End of Chapter Exercises: Solutions
Chapter 8
1. A project in Bhutan uses $100 of imported goods, and 2000 Rupees worth of
domestic labour, paid at the minimum wage, to produce exported goods worth
$200 on world markets. The opportunity cost of labour in Bhutan is estimated to
be 40% of the minimum wage. The official exchange rate is 15 Rupees = $1, and
the shadow-exchange rate is 20 Rupees = $1.
(i) Work out the NPV of the project:
(a) using the UNIDO approach
(b) using the LM approach.
(ii)What is the relationship between the two values?
Answer:
Define OER = 1/15, SER = 1/20
(i)
(a) UNIDO: 200/SER - 100/SER – 0.4(2000) = 1200 Rupees
(b)LM: 200/OER – 100/OER – 0.4(SER/OER)(2000) = 900 Rupees
(ii)
LM(OER/SER) = UNIDO: 900(20/15) = 1200.
2. Suppose that the annual value of a country’s imports is $1 million and the annual
value of its exports is $750,000. It imposes a tariff of 20% on all imported goods,
and exported goods receive a 10% subsidy. The official exchange rate is 1500
Crowns = $1. Work out the appropriate value for the shadow-exchange rate.
Answer:
OER= 1/1500 $/Crown.
SER=OER/(1+FEP).
(1+ FEP) = (1/1.75)1.2 + (.75/1.75)1.1 = 1.157
SER=1/(1500 times 1.157) = .000576 $/Crown or 1735.5 Crowns/$.