GDP Purchasing Power Parity (PPP) 2

Question 1

If a standard basket of goods costs $100 in the United States and ¥1,200 in Japan, what is the PPP-implied exchange rate (dollars per yen)?

Accepted Answer

$0.083 per yen

Answer

The PPP exchange rate = US price / Japan price = $100 / ¥1,200 = $0.083 per yen, meaning one yen should be worth approximately $0.083 based on purchasing power.

Question 2

If the PPP-implied exchange rate is $1.25 per pound sterling but the market exchange rate is $1.50 per pound, the pound is considered to be:

Accepted Answer

Overvalued relative to PPP

Answer

Since the pound trades at $1.50 in the market but PPP suggests it should only be worth $1.25, the pound is overvalued — it buys more dollars than its purchasing power justifies.

Question 3

Which of the following is a primary reason why absolute PPP does not hold precisely in practice?

Accepted Answer

Non-tradable goods and services can have vastly different prices across countries without triggering arbitrage

Answer

Non-tradable items like haircuts, rent, and local utilities have prices that can diverge significantly across countries because they cannot be arbitraged internationally.

Question 4

The Balassa-Samuelson effect helps explain why richer countries tend to have higher overall price levels. Its core argument is that:

Accepted Answer

Higher productivity in tradable sectors drives up wages economy-wide, making non-tradable services more expensive

Answer

The Balassa-Samuelson effect shows that productivity gains in tradable goods raise wages throughout the economy, pushing up prices for non-tradable services and making rich countries more expensive overall.

Question 5

Relative PPP, as distinct from absolute PPP, predicts that:

Accepted Answer

Changes in exchange rates will reflect differences in inflation rates between countries over time

Answer

Relative PPP focuses on changes: if Country A has higher inflation than Country B, Country A's currency should depreciate by approximately that inflation differential.

GDP - Gross Domestic Product Practice Test

GDP - Gross Domestic Product Practice Test

GDP Purchasing Power Parity (PPP) 2