Suppose the exchange rate between the U.S. dollar and the Jamaican dollar was $1 U.S. = $40 Jamaican dollars. A beach towel sells for $20 in Miami and $60 Jamaican in Negril.
A) Purchasing power parity does not prevail with these prices.
B) The U.S. dollar would be expected to depreciate.
C) The Jamaican dollar would be expected to appreciate.
D) All of the above are correct.

Question

Quizplus · Accepted Answer

Purchasing power parity (PPP) suggests that in the absence of transportation costs and barriers to trade, identical goods should sell for the same price when price is expressed in a common currency. Here, the beach towel sells for $20 in Miami and, given the exchange rate, should sell for $800 Jamaican dollars in Negril to maintain PPP. However, it sells for only $60 Jamaican dollars, indicating PPP does not prevail. This discrepancy suggests the Jamaican dollar is undervalued or the U.S. dollar is overvalued, leading to expectations of the Jamaican dollar appreciating and the U.S. dollar depreciating to restore PPP.

Suppose the Exchange Rate Between the U