Suppose the exchange rate between the U.S. dollar and the Mexican peso was $1 = 5 pesos. A can of Pepsi sells for $2 in Boston and 12 pesos in Mexico City.
A) The U.S. dollar would be expected to depreciate.
B) Purchasing power parity prevails with these prices.
C) Purchasing power parity does not prevail with these prices.
D) None of the above answers is correct.

Question

Quizplus · Accepted Answer

According to the purchasing power parity theory, the exchange rate between two countries should adjust until the price of a similar basket of goods is the same in both countries. In this case, the price of a can of Pepsi is $2 in the US and 12 pesos (equivalent to $2.4) in Mexico. This indicates that the Mexican peso is overvalued relative to the US dollar, and therefore, purchasing power parity does not prevail.

Suppose the Exchange Rate Between the U