Use the table that follows to answer this ques-tion. Treat the country listed as the homecountry, and treat the United States as theforeign country. Suppose the cost of the mar-ket basket in the United States is P US = $190.Check to see whether purchasing power par-ity (PPP) holds for each of the countrieslisted, and determine whether we should ex-pect a real appreciation or real depreciationfor each country (relative to the UnitedStates) in the long run. For the answer, createa table similar to the one shown and fill in theblank cells. (Hint: Use a spreadsheet applica-tion such as Excel.)P R O B L E M SPrice of Is FX CurrencyPrice of U.S. Basket Real Is FX Expected toCountry Market in FX Exchange Does PPP Currency Have Real(currency measured Per $, Basket (Pus times Rate, Hold? Overvalued or Appreciation orin FX units) EFX/$ (in FX) EFX/$ ) qCOUNTRY/US (yes/no) Undervalued? Depreciation?Brazil (real) 2.1893 520India (rupee) 46.6672 12,000Mexico (peso) 11.0131 1,800South Africa (rand) 6.9294 800Zimbabwe (Z$) 101,347 4,000,000
Question
Use the table that follows to answer this ques-tion. Treat the country listed as the homecountry, and treat the United States as theforeign country. Suppose the cost of the mar-ket basket in the United States is P US = , Basket (Pus times Rate, Hold? Overvalued or Appreciation orin FX units) EFX/ ) qCOUNTRY/US (yes/no) Undervalued? Depreciation?Brazil (real) 2.1893 520India (rupee) 46.6672 12,000Mexico (peso) 11.0131 1,800South Africa (rand) 6.9294 800Zimbabwe (Z$) 101,347 4,000,000
Solution
To answer this question, we need to calculate the price of the U.S. basket in foreign currency (Pus times EFX/$) for each country and compare it with the price of the market basket in that country. If they are equal, PPP holds. If the price of the U.S. basket in foreign currency is higher, the foreign currency is overvalued and we should expect real depreciation. If it's lower, the foreign currency is undervalued and we should expect real appreciation.
Here's the table filled in:
| Country | Price of Market Basket in FX | Real Exchange Rate, EFX/$ | Price of U.S. Basket in FX (Pus times EFX/$) | Does PPP Hold? | Is FX Currency Overvalued or Undervalued? | Expected to Have Real Appreciation or Depreciation? |
|---|---|---|---|---|---|---|
| Brazil (real) | 520 | 2.1893 | 190*2.1893 = 415.97 | No | Undervalued | Appreciation |
| India (rupee) | 12,000 | 46.6672 | 190*46.6672 = 8866.77 | No | Undervalued | Appreciation |
| Mexico (peso) | 1,800 | 11.0131 | 190*11.0131 = 2092.49 | No | Undervalued | Appreciation |
| South Africa (rand) | 800 | 6.9294 | 190*6.9294 = 1315.59 | No | Undervalued | Appreciation |
| Zimbabwe (Z$) | 4,000,000 | 101,347 | 190*101,347 = 19265693 | No | Overvalued | Depreciation |
Please note that this is a simplified analysis and real world currency values are influenced by many other factors.
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