a) Explain absolute purchasing power parity. What do we mean by "relative purchasing power parity"? What is the purchasing-power-parity doctrine? Describe the Balassa-Samuelson critique of this doctrine: present this critique algebraically and discuss its empirical relevance. How does puzzle 5 in Rogoff and Obstfeld relates to purchasing power parity and are they able to provide an explanation on why it exists.

b) In the US Virginia and Maryland are bordering states that have imposed very different taxes on cigarettes. For example, in 1998 Maryland's tax per pack of $0.36 was about twelve times the Virginia tax. Since transportation costs cannot be the answer to these bordering states, how are markets being segmented? As an economist are you surprised to learn that Maryland arrests people found with large quantities of cigarettes lacking the Maryland state tax stamps?