double/triple/quadruple double/triple/quadruple double/triple/quadruple Wiknam/E

Question

double/triple/quadruple

double/triple/quadruple

double/triple/quadruple

Wiknam/Ectenia

9. Problems and Applications Q9 Purchasing-power parity holds between the nations of Ectenia and Wiknam, where the only commodity is Spam. In 2015, a can of Spam cost 4 dollars in Ectenia and 24 pesos in Wiknam. The exchange rate between Ectenian dollars and Wiknamian pesos waspesos per dollar. Over the next 35 years, inflation is expected to be 2 percent per year in Ectenia and 4 percent per year in Wiknam. If this inflation comes to pass, what will happen over this period to the price of Spam and the exchange rate? Over this period, the price of Spam in Ectenia will 70 from Chapter 27.) The exchange rate between the two countries will and the price of Spam in Wiknam will will likely have a higher nominal interest rate. 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 Which of the following statements explains the flaw in your friend's logic? O The scheme would work only if the real interest rates are the same in both nations. The scheme would work only if there is greater inflation in one nation than in the other. Nominal exchange rates adjust for the effects of inflation

Explanation / Answer

Question 9

Cost of a can of Spam in Ectenia = 4 dollars

Cost of a can of Spam in Wiknam = 24 pesos

Exchange rate (pesos per dollars) = 6 pesos per dollar

So,

The exchange rate between Ectenia dollars and Wiknamian pesos was 6 pesos per dollar.

Expected inflation rate in Ectenia = 2%

Price in Ectenia will double in (70/2) 35 years.

Expected inflation rate in Wiknam = 4%

Price in Wiknam will double in (70/4) 17.5 years.

So,

Over this period, the price of Spam in Ectenia will double, and the price of Spam in Wiknam will Quadruple.

The exchange rate between the two countries will double.

Higher the inflation rate, higher will be the nominal interest rate.

So,

Wiknam will likely have a higher nominal interest rate.

The following statement explains the flaw in logic -

The scheme would work only if the real interest rates are the same in the both nations.

Hence, the correct answer is the option (1).

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