Question

1. In New York, a can of coffee costs about $5 and in Saudi Arabia, it costs about 20 Saudi Riyals. If the exchange rate is about 0.27 dollars per riyal, what is the real exchange rate?
2. Analyze the impact of Saudi Riyal appreciation in US dollar for each of the following cases
   1. A US firms plans to invest in Saudi Arabia

2. You are planning to visit USA in summer holidays ​​​​​​

Explain what will happen to the size of both M1 and M2 in each of the following situations:

1. Sahar withdraws $300,000 from her checking account to pay for her admission fee in US.
2. Muntaha transfers $5,000 from her checking account to her saving account. decrease M1 and not change M2.

Answer 1

a Can of Coffee: $5, Saudi Arabia 20 riyals. 1 riyal = 0.27 $. Dollar value is high. $1 dollar = 0.27*x = 3.7 riyals (1/0.27)

Real exchange rate formula is Nominal exchange rate * Domestic price / Foreign price

= 3.7/1 $ * 5/coffee can / 20 / coffee can

= 3.7* 5/20

= 18.5/20

= 0.925 Saudi arabian coffee can / US coffee can.

If one wants the other way than

0.27/1 * 20/5

1.08 US coffee cans / Saudi arabian can.

b. Saudi Riyal appreciation means if $1 = 4 riyals, if Riyal appreciates it will $1= 3 riyals.

1. If a US firm plans to invest in Saudi Arabia, it will have to shell out the same number of dollars but the number of riyals will reduce. So if the price is quoted in Riyals, then he will have to pay more dollars, but if the price is quoted in dollars than he will just have to transfer the cash.

ii. Less number of riyals equals the dollar, so I will have to spend less for a holiday in US.

Checking account is a deposit account

a. Sahar withdraws $300,000, so cash will increase which will increase M1, but deposit account also comes in M1, so M1 will balance out and there is no change. No change in M2 as well.

b. $5,000 transferred from checking which is part of M1, so M1 will reduce, while M2 will stay the same as earlier $5,000 was a part of M1, now it is a part of M2.