Suppose that the United States and the United Kingdom return to the gold standard. The United States sets the price of gold equal to $500 per ounce, and the United Kingdom sets the price of gold at £200 per ounce. What is the $-£ exchange rate?
A) $0.40 = £1
B) $2.50 = £1
C) $500 = 1 ounce
D) £200 = 1 ounce

Question

Quizplus · Accepted Answer

To compute the exchange rate between the two currencies, we need to consider the relative price of gold in the two countries. If the price of gold is $500 per ounce in the US and £200 per ounce in the UK, then we can use the principle of purchasing power parity (PPP) to determine the exchange rate. PPP suggests that the exchange rate should be such that the same basket of goods (in this case, an ounce of gold) should cost the same in both countries.

Thus, we can set up the following proportion:

$500 / 1 ounce = £200 / 1 ounce

Solving for pounds per dollar gives:

£1 = $500 / £200 = $2.50

Therefore, the exchange rate is $2.50 = £1.

Suppose That the United States and the United Kingdom Return