Question 1 The theory of purchasing power parity of the exchange rate states that changes in the nominal exchange rate arise from differences in inflation rates among countries. a. Use economic analysis to evaluate purchasing power parity theory. (25 marks) b. How might the purchasing power parity theory be modified so that it better explains exchange rate changes. (25 marks) Question 2 Use the exchange rate diagram to illustrate and explain what will happen in each of the following cases. a. A decrease in the domestic interest rate (10 marks) b. A decrease in the foreign interest rate (10 marks) c. A decrease in the expected domestic inflation rate (10 marks) d. A decrease in tariffs on imports (10 marks) e. A decrease in the expected foreign inflation rate (10 marks) Question 1 The theory of purchasing power parity of the exchange rate states that changes in the nominal exchange rate arise from differences in inflation rates among countries. a. Use economic analysis to evaluate purchasing power parity theory. (25 marks) b. How might the purchasing power parity theory be modified so that it better explains exchange rate changes. (25 marks) Question 2 Use the exchange rate diagram to illustrate and explain what will happen in each of the following cases. a. A decrease in the domestic interest rate (10 marks) b. A decrease in the foreign interest rate (10 marks) c. A decrease in the expected domestic inflation rate (10 marks) d. A decrease in tariffs on imports (10 marks) e. A decrease in the expected foreign inflation rate (10 marks)