Suppose absolute PPP holds and prices are perfectly flexible (i.e. absolute PPP holds even in the...

 

Transcribed Image Text:

Suppose absolute PPP holds and prices are perfectly flexible (i.e. absolute PPP holds even in the short-run). a) Calculate the equilibrium exchange rate Eus$/€ (i.e. dollars per euro) based on the information below: Real money demand in the United States is given by L$ = 1.2Yus-2R$ Real money demand in the Eurozone is given by Le = 3Y Eur - 4R€ Where Yx gives national income in country/region x and Rx is the interest rate for currency x. The specific values, including also for nominal money supplies, are as in the following table: Yus = 20 R$ = 2 Nominal Money Supplies Msus = 6,000 Yeur = 18 R€ = 1 MS Eur 10,000 b) Now assume that there is a sudden increase in productivity that increases national income in the United States to 23.333 (everything else stays the same). Recalculate the equilibrium exchange rate Eus$/€ (to one decimal point is fine) c) Did the dollar appreciate or depreciate in part b)? Explain your result. Suppose absolute PPP holds and prices are perfectly flexible (i.e. absolute PPP holds even in the short-run). a) Calculate the equilibrium exchange rate Eus$/€ (i.e. dollars per euro) based on the information below: Real money demand in the United States is given by L$ = 1.2Yus-2R$ Real money demand in the Eurozone is given by Le = 3Y Eur - 4R€ Where Yx gives national income in country/region x and Rx is the interest rate for currency x. The specific values, including also for nominal money supplies, are as in the following table: Yus = 20 R$ = 2 Nominal Money Supplies Msus = 6,000 Yeur = 18 R€ = 1 MS Eur 10,000 b) Now assume that there is a sudden increase in productivity that increases national income in the United States to 23.333 (everything else stays the same). Recalculate the equilibrium exchange rate Eus$/€ (to one decimal point is fine) c) Did the dollar appreciate or depreciate in part b)? Explain your result.

Answer rating: 100% (QA)

a The equilibrium exchange rate is calculated using the absolute purchasing power parity PPP formula ... View the full answer