a. As the chart shows, there is an upward trend in the long-run behavior of the

Question

a. As the chart shows, there is an upward trend in the long-run behavior of the real exchange rate. According to the Balassa-Samuelson explanation of long-run changes in real exchange rates, which of these countries is likely to be a developing country and which is likely to an advanced, developed country?

                        the developing country is _________

                        the advanced country is _________

b. Using the trend line to represent the equilibrium real exchange rate, is the value of country X’s currency in 2014 overvalued or undervalued when measured in terms of country Y’s currency?

Real Exchange Rate: Price of Country X's goods relative to (divided by) the price of Country Y's goods 1.200 T 1.000 0.800 0.600 0.400 0.200 0.000

Explanation / Answer

A) According to the Balassa-Samuelson explanation of long-run changes in real exchange rates,

The consumer price levels in developed countries are systematically higher than in developing ones.

So as per the chart,

The Developing country is X

The Advanced country is Y

B) As per chart in 2014, Country X’s currency is undervalued when measured interm’s of country Y’s Currency.

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