Suppose that the price of an identical sport-utility vehicle is $32,000 in U.S. dollars in the United States and $32,000 in Canadian dollars in Canada. Suppose in addition that the exchange rate between Canada and the United States is one Canadian dollar equals $0.75 U.S. dollar. Based on this information what will happen to the exchange rate between the United States and Canada?
A) The value of the U.S. dollar will fall as U.S. residents purchase SUVs in Canada.
B) The exchange rate will stay the same because purchasing power parity already holds.
C) The value of the Canadian dollar will fall because Canadian prices are lower than U.S. prices.
D) The value of the Canadian dollar will fall as Canadians purchase SUVs in the United States.

Question

Quizplus · Accepted Answer

The price of the SUV in Canada is effectively $24,000 USD (32,000 CAD * 0.75 USD/CAD), which is cheaper than in the U.S. This will lead U.S. residents to buy SUVs in Canada, increasing demand for Canadian dollars and causing the value of the U.S. dollar to fall relative to the Canadian dollar.

Suppose That the Price of an Identical Sport-Utility Vehicle Is