If the SA price level is increasing by 3 per cent annually and the US price level is increasing by 5 per cent annually, by what percentage would the rand price of US dollars need to change according to purchasing power parity?
A)depreciate by 5 per cent per year
B)appreciate by 3 per cent per year
C)appreciate by 5 per cent per year
D)depreciate by 2 per cent per year

Question

Quizplus · Accepted Answer

According to purchasing power parity, the exchange rate needs to adjust such that the same basket of goods costs the same in both countries. If the US price level is increasing by 5% annually and the SA price level is increasing by 3% annually, then the cost of the same basket of goods will increase faster in the US than in SA. This means that the rand price of the US dollar needs to decrease (depreciate) in order to maintain purchasing power parity. Specifically, it needs to depreciate by the difference in inflation rates, which is 5% - 3% = 2% per year. Therefore, the answer is D) depreciate by 2% per year.

If the SA Price Level Is Increasing by 3 Per