If the UK price level is increasing by 3 per cent annually and the Swiss price level is increasing by 5 per cent annually, by what percentage would the pound sterling price of Swiss francs need to change according to purchasing power parity?
A) depreciate by 5 per cent per year
B) appreciate by 3 per cent per year
C) appreciate by 5 per cent per year
D) depreciate by 2 per cent per year

Question

Quizplus · Accepted Answer

According to purchasing power parity, the exchange rate should adjust to compensate for differences in inflation rates between two countries. In this case, since the UK inflation rate is lower than Switzerland's, the pound sterling should appreciate relative to the Swiss franc to maintain purchasing power parity. The percentage change would be the difference between the two inflation rates, which is 5% - 3% = 2%. Therefore, the pound sterling price of Swiss francs would need to depreciate by 2% per year to maintain purchasing power parity. Thus, the correct answer is D- depreciate by 2 per cent per year.

If the UK Price Level Is Increasing by 3 Per