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The United States and Kenya Are Trading Partners for a Variety

Question 285

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The United States and Kenya are trading partners for a variety of goods and services and the nominal exchange rate between the United States and Kenya is $1 U.S. = 80 Kenyan shillings. If a burger in the United States costs $1 and a burger in Kenya costs 80 shillings:
A) What is the real exchange rate?
B) Suppose there is inflation in Kenya and the cost of the same burger rises to 160 Kenyan shillings so that $1 U.S. can now only purchase half a burger in Kenya. Can you explain how PPP will hold in the long run? (Ignore transportation costs, tariffs, etc.)

Correct Answer:

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A) 1:1
B) When there is inflation, there...

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