Question

Highland, Lowland and Midland are three countries in a continent. The countries engage heavily in trade with each other and have almost identical facilities provided to consumers by both the private sector and public sector. In 2005, Highland had a Nominal bill of its Economy which amounted to 750 million Krona out of which 89% are from traded goods, Midland had a Nominal bill that amounted to 1.4 trillion Dinar out of which 78% are from traded goods and Lowland had a Nominal bill which amounted to 300 million Rand out of which 100% is from traded goods. The following information is given:

E (KRONA|DINAR) = 0.7

E (DINAR|RAND) = 0.495

E (RAND|US DOLLAR) = 1.2

All the above rates are official exchange rates.

Globally, the living standards of all the countries are measured against the living standards in the United States. In order to see that, the BIG MAC Index is used to determine how much the MAC would cost in each of these countries in USD. In Highland, a MAC approximately costs 2 Krona, in Midland, a MAC costs twice as much as in Highlands, In Lowland, a MAC costs around 1.2 Rand and In US, the MAC costs around $6.32.

1. Calculate the Exchange rate of all the currencies per US Dollar at the official rates.
2. Calculate the Nominal GDP and PPP GDP of Highland, Midland and Lowland in US Dollars.
3. What can you conclude from your answers in part B.?
4. In 2006, Highland and Midland jointly invaded Lowland and took over the country. If Highland took 60% of the Nominal GDP and Midland took 40% of the Nominal GDP. What are the percentage increases in their PPP GDP? (Assume all the exchange rates are unchanged)

Answer 1

A) We have the following exchange rates given,

Thus E3, E4 and E5 are the exchange rate of all the currencies per US Dollar at the official rates.

B) Exchange rates in terms of PPP in US Dollars is

We use following formula to caluclate the GDP's

Thus, the nominal GDP and PPP GDP are given in table below:

	NominalGDP(in local currency)	Exchange rate(in US dollars)	Nominal GDP(in US dollars)	Exchange rate(in PPP terms in US dollars)	Nominal GDP(in PPP terms)
Highland	750m	0.4158	1.8b	0.3165	2.37b
Midland	1.4tr	0.594	2.36tr=2360b	0.631	2218.7b
Lowland	300m	1.2	250m=0.25b	0.19	1.58b

c) We see that that nominally, the lowland has lower GDP. But if we take into account the PPP (i.e purchasing power capacity in the countries), we get the close estimate of the comparision betwen three countries.

d) After the invasion, the nomimal GDP becomes

i)Highland: 1.8b + 0.6(0.25) = 1.95b

and Nominal GDP(in PPP) = 1.95*0.4158/0.3165 = 2.562b.

% increase = (2.562/2.37 - 1)*100% = 8.1%

ii) Midland: 2360 + 0.4(0.25) = 2360.1b

and Nominal GDP(in PPP) = 2360.1*0.594/0.631 = 2221.7b

% increase = (2221.7/2218.7 - 1)*100% = 0.135%