Question

A bundle of goods in Japan costs ¥2,698,100 while the same goods and services cost \$25,200...

A bundle of goods in Japan costs ¥2,698,100 while the same goods and services cost \$25,200 in the United States.

a. If purchasing power parity holds, what is the current exchange rate of U.S. dollars for yen?
b. If, over the next year, inflation is 6 percent in Japan and 10 percent in the United States, what will the goods cost next year?
c. Will the dollar depreciate or appreciate relative to the yen over this time period?

According to purchasing power parity, the same good should cost the same in different countries, when expressed in a common currency unit.

(a) Current Exchange rate

Current Exchange rate = ¥2,698,100/\$25,200

Current Exchange rate = 107.07 ¥/\$​​​​​​

Therefore, The current exchange rate should be \$1 = ¥137.74

(b) Next year Cost for goods ;

For Japan (inflation = 6%),

Cost for next year = ¥2,698,100×(1+6/100)

Cost for next year = ¥2,698,100 × (1.06)

Cost for next year = ¥2859986

Hence, the cost of goods for next year in Japan will be ¥2859986

For U.S (inflation = 10%)

Next year Cost = \$25,200 × (1+0.10)

Next year Cost = \$25,000 × 1.1

Next year Cost = \$27,500

Hence, the next year Cost of goods for U.S will be \$27,500

(c)

It is clear that, dollar is appreciated

Appreciation is the increase in the value of one currency in terms of another.

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