Question

Sydney to Phoenix.??Terry Lamoreaux has homes in both? Sydney, Australia and? Phoenix, Arizona. He travels between the two cities at least twice a year. Because of his frequent trips he wants to buy some? new, high quality luggage.? He's done his research and has decided to go with a Briggs and Riley brand? three-piece luggage set. There are retails stores in both Phoenix and Sydney. Terry was a finance major and wants to use purchasing power parity to determine if he is paying the same price no matter where he makes his purchase.

a. If the price of the? 3-piece luggage set in Phoenix is ?$859 and the price of the same?3-piece set in Sydney is ?A$922 using purchasing power? parity, is the price of the luggage truly equal if the spot rate is ?A$1.0733?/$?

b. If the price of the luggage remains the same in Phoenix one year from? now, determine what the price of the luggage should be in Sydney in? one-year's time if PPP holds true. The U.S. Inflation rate is 1.13% and the Australian inflation rate is 3.14%. ( Round to the nearest cent)

Answer 1

a)As per PPP theory,exchange rate between the countries is equal to ratio of the currencies respective purchasing power.

Here,ratio of currencies respective power should be equal to given exchange rate for the price of luggage being equal.

Ratio=price in sydney/price in phoenix=922/859=A$1.0733/$ which is equal to given spot rate

Hence Here PPP holds good and prices are truly equal

b)Given spot rate =A$1.0733/$ , Inflation rate in US=1.13% ,Inflation rate in Australia=3.14%

Now As per PPP, spot rate after one year/1.0733=1.0314/1.0113

Hence spot rate after one year=A$1.0946/$

Price after one year in phoenix=$859

Price of the luggage in sydney=859*1.0946=A$940.26