Suppose the exchange rate between the U.S.dollar and the Japanese yen is initially 90 yen per dollar.According to purchasing power parity, if the price of traded goods falls by 5 percent in the United States and rises by 5 percent in Japan, then the exchange rate will become
A) 72 yen per dollar.
B) 81 yen per dollar.
C) 99 yen per dollar.
D) 108 yen per dollar.

Question

Quizplus · Accepted Answer

According to purchasing power parity, if the price level in one country falls relative to the other, the currency of the country with the lower price level should appreciate. In this case, the price level fell in the United States and rose in Japan. Therefore, the U.S. dollar should appreciate relative to the yen. To find the new exchange rate, we can use the formula:

New exchange rate = Old exchange rate × (1 + percentage change in U.S. price level) ÷ (1 + percentage change in Japanese price level)
New exchange rate = 90 × (1 - 0.05) ÷ (1 + 0.05)
New exchange rate = 81 yen per dollar

Suppose the Exchange Rate Between the U