22 Questions
What is the real exchange rate a measure of?
The cost of a basket of goods in one country relative to the cost of the same basket of goods in another country
What is a reason why a country needs to buy and sell foreign currencies?
To facilitate international trade and investment
What is the law of one price?
The idea that identical products should sell for the same price everywhere
What is the theory of Purchasing Power Parity (PPP) an application of?
The law of one price across countries
What is an example of a 'long-term' factor that affects the exchange rate?
International investment
What is an example of a 'short-term' factor that affects the exchange rate?
Speculation
What is the nominal exchange rate?
The rate at which one can exchange the currency of one country for the currency of another country.
Which of the following is an example of depreciation?
NT$30/$1 → NT$32/$1
What is the real exchange rate?
The rate at which one can exchange goods and services from one country for goods and services from another country.
What does an appreciation in the value of a currency mean?
The value of the currency has increased relative to another currency.
How are exchange rates typically quoted?
Foreign currency per unit of domestic currency.
What is the result of NT$30/$1 → NT$28/$1?
The NTD has appreciated relative to the dollar.
What is the opposite of depreciation?
Appreciation
What is the result of NT$30/$1 → NT$32/$1?
The NTD has depreciated relative to the dollar.
What is the concept that states that the same product must sell for the same price in two different locations?
Law of One Price
What is the formula to convert the price of an apple in Taiwan to its equivalent price in the US?
PD = EX × PF
What is the concept that states that the same amount of money can buy the same quantity of goods and services in two different countries?
Purchasing Power Parity
What is the formula to express the Purchasing Power Parity concept?
PD = EXD/F × PF
What is the relationship between the exchange rate and the prices of goods and services in two different countries?
The exchange rate is inversely proportional to the prices of goods and services
What is the implication of the Purchasing Power Parity concept on the exchange rate?
The exchange rate will adjust to equalize the purchasing power of currencies
What is the long-run determinant of the exchange rate?
Purchasing Power Parity
What is the relationship between the prices of goods and services in the domestic and foreign markets?
The prices of goods and services are directly proportional in the domestic and foreign markets
Study Notes
Foreign Exchange Market
- The law of one price states that identical products should sell for the same price everywhere.
Purchasing Power Parity (PPP)
- PPP is the application of the law of one price across countries for all goods and services or for representative groups (baskets) of goods and services.
- It states that the same amount of money can buy the same quantity of goods and services in different countries.
- PPP can be expressed as PD = EX × PF, where PD is the domestic price level, EX is the exchange rate, and PF is the foreign price level.
Exchange Rate in the Long Run
- The exchange rate is determined by the law of one price and PPP in the long run.
- The real exchange rate is the rate at which one can exchange the goods and services from one country for the goods and services from another country.
Nominal Exchange Rate
- The nominal exchange rate is the rate at which one can exchange the currency of one country for the currency of another country.
- It can be quoted as foreign currency per unit of domestic currency (indirect quotation) or domestic currency per unit of foreign currency (direct quotation).
Appreciation and Depreciation
- Appreciation is an increase in the value of a currency relative to another currency.
- Depreciation is a decrease in the value of a currency relative to another currency.
Demand and Supply of Foreign Exchange
- The demand for foreign exchange comes from trade and investment.
- The supply of foreign exchange comes from exports and investment income.
Most Traded Currencies in the World
- The most traded currencies in the world include the US dollar, euro, yen, and pound.
This quiz covers the concept of foreign exchange market, exchange rate, and the law of one price. It also touches on arbitrage and demand and supply.
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