Question

La reerences Mailings Review View Come Courier 12 Aa A DE Paste 3 BIUab x *'ADA Share L TA a E Styles Styles Pane 5. Use the information below to answer question 5. MY U.S. 2,000 500 10,000 5,000 U.X. a. Calculate the price levels in both the u.s. and the U.K. according to the quantity theory of money. b. Calculate the nominal exchange rate (dollars per pound) assuming the quantity theory of money and absolute PPP. c. Assume that the u.s. money supply rises to 2,200 in the U.S. and to 600 in the U.K. Calculate the new nominal exchange rate.

Answer 1

1. From Quantity theory of money we have: MV=PY

M= 1/V*(PY)

1/V = L

M = L*PY

P = M/LY

For US:

Pus = 2000/0.1*10,000 = $2

Puk = 500/0.04*5000 = 2.5 pound

b)

Nominal exchange rate (dollars per pound) when absolute PPP holds = Pd/Pf

= $2/2.5pound = 0.8 dollars per pound.

2. US money supply = 2000 and UK = 600

P’us = 2200/0.1*10,000 = 2.2

P’uk = 600/0.04*5000 = 3

Nominal exchange rate = 3/2.2 = 1.36 dollars per pound.