Question

1. Assume that an item costs $100 in the United States. The exchange rate between the U.S. and Japan is: $1 = 100 yens. Which theory supports the idea that the item that sells for $100 in the U.S. is currently selling in Japan for 10,000 yens?

Answer 1

• Purchasing power parity is an economic theory that states prices of goods and services should equalize between countries over time. International trade allows people to shop around for the best price.

   This theory that states that the exchange rate between two countries is equal to the ratio of the currencies' respective purchasing power.

Given ,

In question,

An item cost $100 in US.

Exchange rate is $1 = 100Yen

If law of one price holds,i.e., purchasing power parity holds,the item should cost same amount in japan also using current exhange rate.

i.e., It should cost 100$*100Yen/1$ = 10000Yen