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difference between the real exchange rate and the nominal exchange rate

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1. Explain the difference between the real exchange rate and the nominal exchange rate.

2a. If a Japanese car costs 500,000 yen, if a similar Canadian-produced car costs $10,000, and if a dollar can buy 100 yen, what are the nominal and real exchange rates?

2b. Explain the relationship among saving, investment, and net foreign investment.

3. Explain two reasons why purchasing power parity does not hold for all goods and services.

4. What is happening to Canada's real exchange rate in each of the following situations? Explain.

a. The Canadian nominal exchange rate is unchanged, but prices rise faster in Canada then abroad.

b. The Canadian nominal exchange rate is unchanged, but prices rise faster abroad then in Canada.

c. The Canadian nominal exchange rate declines, and prices are unchanged in Canada and abroad.

d. The Canadian nominal exchange rate declines, and prices rise faster abroad then in Canada.

5. "Even though Canada is a small, open economy, trading mostly with the United States, it can still have its own independent monetary policy." True or False. Explain.

6. If Canada's saving is held constant, predict the impact of an increase in net foreign investment on Canada's accumulation of domestic capital.

7. If coke sells for $1.20 Canadian and for .75 pounds in the U.K, determine what the exchange rate should be if purchasing power parity holds.

8. The economits, and international news magazine, regularly collects data on the price of McDonald's Big Mac hamburger in different countries in order to examine the theory of purchasing power parity.
a. Why might the Big Mac be a good product to use for this purpose?
b. Based on the Big Mac data, purchasing power parity appears to hold roughly across some countries, though not across others. Why might the assumptions underlying the theory of purchasing power parity not hold exactly for Big Macs?

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2. A 1991 The Wall Street Journal cover page article entitled "Foreign Rate Increases May Worsen Slump" explained how the German central bank raised domestic interest rates in order to reduce inflation below the 3% level. At the same time, the U.S. central bank reduced domestic interest rates to fight the deepening recession in the United States.
a. Explain the pressures that rising German interest rates put on the other European Union (EU) countries' currencies. Specifically, assume exchange rates within the EU were absolutely fixed. Explain the economic effects a rise in the real German interest rate put on the DM/FF exchange rate and what the French central bank (i.e., the Bank of France) would have to do to keep the exchange rate fixed.
b. Explain the economic effects the rise in German interest rates put on the DM/FF exchange rate and what the German central bank (i.e., the Bundesbank) would have to do to keep the exchange rate fixed.
d. What is the Phillips Curve? Are your results in question (1a) consistent with the Phillips Curve?
3. In 1991, Argentina adopted a currency board that had the responsibility to maintain a fixed exchange rate between the Argentine peso and the U.S. dollar ($1 = 1 Argentine Peso). Through the Convertibility Law, Argentina also established that each peso in circulation had to be 100% collateralized with reserves in the Central Bank, assuring 100% coverage of Argentine monetary base. Assume the government promised to reduce the surging unemployment rate by trying to stimulate significant new economic growth by means of expansionary monetary policy. Since it would be constrained by the Convertibility Law from increasing the monetary base, suppose the central bank expanded the money supply by reducing the reserve ratio. Explain the economic effects that expansionary monetary policy would have on Argentina's real and nominal GDP, monetary base, money supply, real and nominal interest rates, current account, financial account, level of international reserves, real investment spending, unemployment rate, inflation rate, and velocity of money.

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