   Chapter 13, Problem 9PA

Chapter
Section
Textbook Problem

Purchasing-power parity holds between the nations of Ectenia and Wiknam, where the only commodity is Spam.a. In 2015, a can of Spam costs 4 dollars in Ectenia and 24 pesos in Wiknam. What is the exchange rate between Ectenian dollars and Wiknamian pesos?b. Over the next 20 years, inflation is expected to be 3.5 percent per year in Ectenia and 7 percent per year in Wiknam. If this inflation comes to pass, what will the price of Spam and the exchange rate be in 2035? (Hint: Recall the rule of 70 from Chapter 14.)c. Which of these two nations will likely have a higher nominal interest rate? Why?d. 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. Do you see any potential problems with this idea? Explain.

(a):

To determine

The exchange rate between country Ect and country Wik.

Explanation

If the purchasing power holds, the exchange rate between nations of Ect and Wik when a can of spam costs \$4 in the Ect and 24 pesos in Wik is calculated as follows:

Exchangerate=UnitcostofspamVik

(b):

To determine

The new exchange rate between country Ect and country Wik.

(c):

To determine

Nominal interest rate.

(d):

To determine

Changes in exchange rate.

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