10 Questions
According to the law of one price, what should the exchange rate be if a car costs birr 180,000 in Ethiopia and $20,000 in the US?
Birr 9/USD
What is the concept behind the law of one price?
Perfect goods arbitrage
If the exchange rate is birr 9.20/USD, what will US citizens do according to the law of one price?
Buy a car in Ethiopia
What happens to arbitrage profit opportunities according to the law of one price?
They are eliminated when prices equalize
If the exchange rate is birr 8.50/USD, how much would the Ethiopian resident save by purchasing a car in the US?
$1,176
According to the absolute purchasing power parity (PPP) theory, if the price of a bundle of goods in Ethiopia is 20 birr and the same bundle costs $2 in the US, what should the exchange rate be?
10 birr/USD
If the price of a bundle of goods in Ethiopia rises from 20 birr to 21 birr, while the price of the same bundle in the US remains at $2, what will happen to the exchange rate according to the absolute PPP theory?
The exchange rate will depreciate to 10.5 birr/USD.
Which statement best describes the relative purchasing power parity (PPP) theory?
The exchange rate will adjust by the amount of the inflation differentials between two economies.
What is the main reason why the absolute version of PPP is unlikely to hold precisely, according to the text?
Both (a) and (b).
If the percentage change in the exchange rate between the birr and the USD is 5%, and the percentage change in the domestic price level in Ethiopia is 8%, what is the percentage change in the foreign price level (US) according to the relative PPP theory?
-3%
Test your knowledge on the law of one price, which states that identical products in different markets will be sold at the same price when expressed in a common currency. Understand the concept of perfect goods arbitrage and how economic agents exploit price differences for profit.
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