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Purchasing-power parity holds between the nations of Ectenia and Wiknam, where the only
Chapter 31, Problem Problems and Applications 31.11(choose chapter or problem)
Purchasing-power parity holds between the nations of Ectenia and Wiknam, where the only commodity is Spam. a. In 2000 a can of Spam costs 2 dollars in Ectenia and 6 pesos in Wiknam. What is the exchange rate between Ectenian dollars and Wiknamian pesos? b. Over the next 20 years, inflation is 3.5 percent per year in Ectenia and 7 percent per year in Wiknam. What will happen over this period to the price of Spam and the exchange rate? (Hint: Recall the rule of 70 from Chapter c. Which of these two nations will likely have a higher nominal interest rate? Why? d. A friend of yours suggests a get-rich-quick scheme: Borrow from the nation with the lower nominal interest rate, invest in the nation with the higher nominal interest rate, and profit from the interest-rate differential. Do you see any potential problems with this idea? Explain.
Questions & Answers
QUESTION:
Purchasing-power parity holds between the nations of Ectenia and Wiknam, where the only commodity is Spam. a. In 2000 a can of Spam costs 2 dollars in Ectenia and 6 pesos in Wiknam. What is the exchange rate between Ectenian dollars and Wiknamian pesos? b. Over the next 20 years, inflation is 3.5 percent per year in Ectenia and 7 percent per year in Wiknam. What will happen over this period to the price of Spam and the exchange rate? (Hint: Recall the rule of 70 from Chapter c. Which of these two nations will likely have a higher nominal interest rate? Why? d. A friend of yours suggests a get-rich-quick scheme: Borrow from the nation with the lower nominal interest rate, invest in the nation with the higher nominal interest rate, and profit from the interest-rate differential. Do you see any potential problems with this idea? Explain.
ANSWER:Step 1 of 4
It has been given that the spam costs 2 dollars and 6 pesos in Ectenia and Wiknam respectively. As it can be observed that the absolute price value of spam in Wiknam is 3 times more than that in Ectenia, it can be deduced that the exchange rate is 3 pesos per dollar.