The table below shows hypothetical indexes for the price levels for Canada and the United States and hypothetical nominal exchange rates between their currencies (the Canadian-dollar price of 1 U.S.dollar). TABLE 34-2 Refer to Table 34-2.According to the theory of purchasing power parity (PPP),the Canadian-U.S.exchange rate in 2014 should have been________,meaning that the actual Canadian dollar in that year was ________ relative to its PPP value.

Question

The table below shows hypothetical indexes for the price levels for Canada and the United States and hypothetical nominal exchange rates between their currencies (the Canadian-dollar price of 1 U.S.dollar).  TABLE 34-2 Refer to Table 34-2.According to the theory of purchasing power parity (PPP),the Canadian-U.S.exchange rate in 2014 should have been________,meaning that the actual Canadian dollar in that year was ________ relative to its PPP value.

Quizplus · Accepted Answer

PPP theory states that the exchange rate between two countries should reflect the relative price levels of the two countries. To calculate the PPP exchange rate, we divide the Canadian price level by the U.S. price level: (110/103) = 1.067. This means that the actual exchange rate of 1.10 is overvalued relative to its PPP value of 1.067, so the Canadian dollar in 2014 was undervalued. Therefore, the correct answer is C - 1.06 undervalued.

The Table Below Shows Hypothetical Indexes for the Price Levels