Multiple-Choice Questions (Chapter 4)

1. Which of the following statements is the most accurate?

(a) Predictions about long-run movements in exchange rates
are important even in the short run.
(b) Predictions about long-run movements in exchange rates
are not important the in short run.
(c) Predictions about long-run movements in exchange rates
are important only in the long run.
(d) Predictions about long-run movements in exchange rates
are often not important in the short run.

2. Which of the following statements is the most accurate? The law

of one price states:
(a)In competitive markets with free of transportation costs and
official barrier to trade, identical goods sold in different
countries must sell for the same price when their prices are
expressed in terms of the same currency.
(b) In competitive markets free of transportation costs and
official barrier to trade, identical goods sold in the same
country must sell for the same price when their prices are
expressed in terms of the same currency.
(c) In competitive markets free of transportation costs and
official barrier to trade, identical goods sold in different
countries must sell for the same price.
(d) Identical goods sold in different countries must sell for
the same price when their prices are expressed in terms of the
same currency.
(e)None of the above
3. Under Purchasing Power Parity,
(a) E$/E = PUS/PE
(b) E$/E = PE/PUS
(c) E$/E = PUS – PE
 (d) None of the above.
4. Which of the following statements is the most accurate?
(a)The law of one price applies only to the general price level.
(b) The law of one price applies to the general price level
while PPP applies to individual commodities.
(c)The law of one price applies to individual commodities while
PPP applies to both the general price level and to individual
commodities.
(d) PPP applies only to individual commodities.
(e)The law of one price applies to individual commodities while
PPP applies to the general price level.
5. Which of the following statements is the most accurate?
(a)If PPP holds true, then the law of one price holds true for
every commodity as long as the reference baskets used to
reckon different countries’ price levels are the same.
(b) If the law of one price holds true for every commodity,
PPP must hold automatically.
(c)If the law of one price holds true for every commodity, PPP
must automatically hold as long as the reference baskets used
to reckon different countries’ price levels are the same.
(d) If the law of one price does not hold true for every
commodity, PPP cannot be true as long as the reference
baskets used to reckon different countries’ price levels are the
same.
(e)None of the above statements is true.
6. Which of the following statements is the most accurate?
(a)Absolute PPP does not imply relative PPP.
(b) Relative PPP implies absolute PPP.
(c)There is no causality relation between the two.
(d) Absolute PPP implies relative PPP.
(e)None of the above statements is true.
7. Which of the following statements is the most accurate?
(a)Relative PPP is valid even when absolute PPP is not, provided
the factors causing deviations from absolute PPP are more or
less stable over different commodities space.
(b) Absolute PPP is valid even when relative PPP is not,
provided the factors causing deviations from relative PPP are
more or less stable over time.
(c)Relative PPP is valid even when absolute PPP is not, provided
the factors causing deviations from absolute PPP are more or
less stable over time.
(d) Relative PPP is not valid when absolute PPP is not.

8. Which of the following statements is the most accurate? In

reality,
(a) the prices of identical commodity baskets, when converted to
a single currency, are the same across countries.
(b) the prices of identical commodity baskets, when converted to
a single currency, differ substantially across countries.
(c) the prices of identical commodity baskets, when converted to
a single currency, do not differ substantially across countries.
(d) the prices of identical commodity baskets, when converted to
a single currency, are often the same across countries.
9. Which of the following statements is the most accurate?
(a)PPP appears to be useful as a short-run explanation of
exchange rate movements.
(b) PPP appears to be of limited use even as a short-run
explanation of exchange rate movements.
(c)PPP appears to be of limited use even as a long-run
explanation of exchange rate movements.
(d) Relative PPP appears to be of limited use even as a short-
run explanation of exchange rate movements.
10. The PPP theory fails in reality because of
(a)Transport costs and restrictions on trade
(b) Monopolistic or oligopolistic practices in goods markets
(c)The inflation data reported in different countries are based
on different commodity baskets.
(d) (a), (b), and (c)
(e ) (a) and (b) only

11. Which of the following statements is the most accurate? In

general,
(a) The monetary approach to the exchange rate is a long run
theory.
(b) The monetary approach to the exchange rate is a short run
theory.
(c) The monetary approach to the exchange rate is both a short
and long run theory.
(d) The monetary approach to the exchange rate is neither a
long run nor short run theory.

12) The monetary approach makes the general prediction that

A) the exchange rate, which is the relative price of American and
European money, is fully determined in the long run by the relative
supplies of those monies.
B) the exchange rate, which is the relative price of American and
European money, is fully determined in the short run by the relative
supplies of those monies and the relative demands for them.
C) the exchange rate, which is the relative price of American and
European money, is fully determined in the short- and long run by
the relative supplies of those monies and the relative demands for
them.
D) the exchange rate, which is the relative price of American and
European money, is fully determined in the long run by the relative
supplies of those monies and the relative demands for them.

13) Under a flexible-price monetary approach to the exchange rate,

A) when the domestic money supply falls, the price level would
eventually fall, increasing the interest rate.
B) when the domestic money supply falls, the price level would fall
right away, causing a reduction in the interest rate.
C) when the domestic money supply falls, the price level would fall
right away, causing an increase in the interest rate.
D) when the domestic money supply falls, the price level would
eventually fall, keeping the interest rate constant.
E) when the domestic money supply falls, the price level would fall
right away, keeping the interest rate constant.
 14. Which of the following statements is the most accurate?
In general, under the monetary approach to the exchange
rate,
(a)While the short -run interest rate does not depend on the
absolute level of the money supply, continuing growth in the
money supply eventually will affect the interest rate.
(b) While the long-run interest rate does depend on the
absolute level of the money supply, continuing growth in the
money supply do not affect the interest rate.
(c)While the long-run interest rate does not depend on the
absolute level of the money supply, continuing growth in the
money supply eventually will affect the interest rate.
(d) The long-run interest rate does not depend on the
absolute level of the money supply, and thus continuing
growth in the money supply will not affect the interest rate.
15. Under PPP (and by the Fisher Effect),
(a)A rise in a country’s expected inflation rate will eventually
cause a more-than proportional rise in the interest rate that
depositors of its currency offer.
(b) A fall in a country’s expected inflation rate will eventually
cause an equal rise in the interest rate that depositors of its
currency offer.
(c)A rise in a country’s expected inflation rate will eventually
cause an equal rise in the interest rate that deposits of its
currency offer.
(d) A rise in a country’s expected inflation rate will
eventually cause a less than proportional rise in the interest
rate that depositors of its currency offer.

16. Given other things equal, in the short run,

(a) The interest rate rises when the domestic money supply falls.
(b) The interest rate decreases when the domestic money supply
falls.
 (c)The interest rate stays constant when the domestic money
supply falls.
(d) None of the above statements is true.
17. Under sticky prices,
(a)A fall in the money supply raises the interest rate to preserve
money market equilibrium.
(b) A fall in the money supply reduces the interest rate to
preserve money market equilibrium.
(c)A fall in the money supply keeps the interest rate intact to
preserve money market equilibrium.
(d) A fall in the money supply does not affect the interest rate
in the short run, only in the long run.
18. Under the monetary approach to the exchange rate,
(a) A reduction in the money supply will cause immediate
currency depreciation.
(b) A rise in the money supply will cause currency depreciation.
(c) A rise in the money supply will cause immediate currency
appreciation.
(d) A rise in the money supply will cause depreciation.
(e) A rise in the money supply will cause immediate currency
depreciation.