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Assume, the current nominal exchange rate is 25 MXN/USD. According to Purchasing Power Parity (PPP), the exchange rate should be 20 MXN/USD. Questions: 1) Is

Assume, the current nominal exchange rate is 25 MXN/USD. According to Purchasing Power Parity (PPP), the exchange rate should be 20 MXN/USD.

Questions:

  • 1) Is the USD over- or undervalued? By how much?

  • 2) What is the real exchange rate between the US and Mexico, that is, how many US "cookies" (goods) does it take to get a Mexican "cookie"?

  • 3) What adjustment might you expect to happen over time? Discuss two alternative adjustments and provide quantitative answers if possible?

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