Question

The exchange rate of dollars per euro is currently $1.00 = €0.95. The U.S. and the European Union allow their currencies to float. Suppose the price of a 2015 Lexus LS600H sedan sells for $114,000 in the United States and €85,000 in Germany. For purchasing power parity of the Lexus sedan, what must this exchange rate become? Specifically, how many euros must $1.00 U.S. dollar be able to buy?  Provide your answer in euros rounded to two decimal places. Use a negative sign "-" for negative values. Do not include any symbols, such as "$," "=," "%," or "," in your answer.

A step by step calculation would be appreciated. If I don't understand, I will ask in the comments before rating.

Answer 1

The purchasing power parity can be attained when exchange rate is such that the relative price of a good becomes same in both countries.

With respect to a good, the purchasing power parity exchange rate can be ascertained by equating the price of that good in both countries.

Price of sedan in United States = $114,000

Price of sedan in Germany = 85,000 euros

Equating the price of sedan in both countries -

$114,000 = 85,000 euros

$1 = [85,000/114,000] euros

$1 = 0.75 euros

So,

For purchasing power parity of the Lexus Sedan,

This exchange rate must become $1.00 = 0.75 Euros