BE630-6-SP/3 QUESTION TWO (a) How can the real exchange rate be used as a measure of international competitiveness? (5 Marks) (b) Consider a world that only comprises 3 goods (Good 1, Good 2, Good 3) and 2 countries (UK and US). Assume that consumption weights of these goods for both countries be (0.50, 0.25, 0.25). The price of the goods at time : are listed below: UK (GBP) US (USD) Good 1 40 20 Good 2 80 55 Good 3 60 175 (i) For each good, what exchange rate is consistent with the law of one price? (2 Marks) (ii) Let the spot exchange rate at time ? be equal to 0.75 GBP per USD. Does absolute purchasing power parity (PPP) hold between the UK and the US? (3 Marks) (c) You are now given the following time f+ / information: UK (GBP) US(USD) Good 1 60 50 Good 2 100 110 Good 3 80 210 Using the information in (b), what spot exchange rate at time t+1 does relative purchasing power parity (PPP) imply