Two fictitious countries, Bigsea and Tadloch, produce only two products: boats, which are traded internationally, and seafood restaurant meals, which are not. Bigseas currency is called big and Tadlochs currency is called tad. [Note k = 1000.]

boats restaurant meals

Bigsea 50 4k

@30k big/boat @15 bigs/meal

Tadloch 30 3k

@400 tads/boat @2 tads/meal

a. If the exchange rate does a perfectly good job translating prices of traded goods (i.e. so that the law of one price holds for traded goods) what is the exchange rate, in bigs per tads? b. Under the exchange rate in (a), what is the ratio of Bigseas GDP to Tadlochs? c. Using the PPP method, calculate the ratio of GDPs first using Bigseas prices, then Tadlochs prices. Why are the ratios different? d. What happens in this example to the ratio between GDPs when the PPP method is employed instead of the exchange rate method? Why does this happen here? Imagine that Tadloch undergoes an inflationary period, such that prices of boats and meals go up by 50%. Assume Bigsea has zero inflation. Assume production quantities are unchanged. e. If the exchange rate continues to do a perfectly good job translating prices of traded goods (i.e. so that the law of one price holds for traded goods), what should the new exchange rate be in bigs per tads? f. Assuming the exchange rate of part e., calculate the ratio of Bigseas GDP to Tadlochs using the exchange rate method. Has it changed from part b)? Why or why not?