A coffee table in Canada sells for C$134.The same coffee table sells for $92 in the United States.The expected inflation rate for the next year in Canada is 10% and the expected one year inflation rate for the United States is 8%.What must the exchange rate be currently for Purchasing Power Parity to hold now,and what must the exchange rate change to in order for Purchasing Power Parity to hold in one year.

Question

Quizplus · Accepted Answer

In order for Purchasing Power Parity to hold now the exchange rate must equal $92/C$134 or $0.6866/C$.In order for Purchasing Power Parity to hold in one year given the expected inflation rates the exchange rate will have to adjust to $0.6741/C$ to reflect the new price of the coffee table in both countries.In one year the coffee table will sell for C$147.4 in Canada and in one year the coffee table will sell for $99.36 in the United States.Therefore the new exchange rate must equal $99.36/C$147.4 or $0.6741/C$.

A Coffee Table in Canada Sells for C$134