Problem Set No. 2.

Purchasing Power Parity and Exchange Rates

 

  1. a) Using the Big Mac Currencies article dated April 21st, show the calculations behind the article's assertion that Japan's Yen is 6% undervalued.

    2. b) Using the data in the chart from that same article calculate how much the Chinese Yuan is over or undervalued.

     

  2. Assume that the Yen's value is determined solely by trade in Big Mac's. Further assume that it is possible to transport Big Mac's costlessly by a transporter like that found in StarTrek. Show graphically how the demand for burgers would change, and then show how the demand for the Yen and the dollar would change.

    3.  

  3. Assume that trade in two goods, Toyotas and the Big Mac, determines the Yen's value. Now assume that Big Mac's are not available through transporters, but require costly tourist travel. Explain whether we would expect purchasing power parity to be perfect between the two countries.

    4.  

  4. More broadly assume that the Yen's value depends upon trade in bonds (purchased for their monetary yields) and consumer goods. If exports of Japanese consumer goods exceed imports of American goods, explain whether Japan is likely to export more bonds (borrow) or buy more bonds (lend).

    5.  

  5. If the Japanese lend additional money abroad each year because foreign interest rates rise to 10%, what effect will this have on their exchange rate (explain in terms of supply and demand).

 

6. If wages for Chinese workers were consistently lower than those for U.S. workers, explain what we would expect to happen to the demand and/or supply (and consequently also for prices) for each of the following markets:

  1. Chinese product markets
  2. Chinese labor markets
  3. Chinese currency markets