Econ 162-A1, A2 Kenny Christianson

Econ 162-A1, A2 Kenny Christianson

Fall 2015 due: October 30

PROBLEM SET NUMBER SIX

1. Suppose that the economy of Loserville has the following distribution of income:

first quintile 10% of aggregate income

second quintile 15% of aggregate income

third quintile 20% of aggregate income

fourth quintile 25% of aggregate income

fifth quintile 30% of aggregate income

a. From the information provided, please derive a Lorenz Curve for Loserville. Show graphically.

b. From the Lorenz Curve you have drawn, find the Gini Coefficient.

2. Suppose that you wake up one morning and find the following exchange rates:

$1 = ¥100

¥1 = €0.05

€1 = $0.50

a. Given these exchange rates, can you profit from international arbitrage? Show and explain.

b. Does Purchasing Power Parity hold in this example? Why or why not?

3. Assume that copper currently sells for $20 per pound in the United States, and for €10 per pound in Germany. The current exchange rate is €1 = $1.50. It costs $1.00 to ship one pound of copper between the countries.

a. Is it possible to profit from international arbitrage? Where should copper be purchased? Where should copper be sold? Show and explain.

b. How would you expect the price of copper to change in both countries over time?

c. If prices are fixed, how would exchange rates have to adjust to bring Purchasing Power Parity?

4. To find the U.S. balance of payments data, go to

http://www.bea.gov

From the BEA home page, click on “Balance of Payments” under “International”, and then click on “News Release: International Transactions”. After reading the news article, answer the following questions:

a. What are the recent trends in the U.S. trade deficit in the past quarter? Why?

b. What are the major components of the Balance of Payments that are discussed in the article? Briefly, how have these been moving in the recent past?

5. Assume that you have $100,000 to invest in either U.S. or French bonds. The U.S. bonds pay 5% interest, while the French bonds pay 4% interest. Both bonds mature in one year. The dollar currently trades for 0.8 euros, and you expect the dollar to trade for 0.5 euros one year from now. Which bond should you purchase? Explain.

6. Go to the Economist magazine website to read about the Big Mac Index:

http://www.economist.com/content/big-mac-index

Read the article and look at the table, and then answer the following questions:

a. What is the “Big Mac” Index? What does it measure?

b. According to the table, which currencies are most overvalued? Undervalued?

c. How would you expect the euro and yen to move against the dollar based on the table?