A base model Schwinn bike costs $100 in the United States and €125 in Europe. What would the purchasing power parity theory's prediction of the dollar/euro exchange rate be based on this example?

Question

Quizplus · Accepted Answer

The purchasing power parity theory states that the exchange rate between two currencies should be equal to the ratio of the prices of a basket of goods in the two countries. In this case, the basket of goods consists of a Schwinn bike. The price of the bike in the United States is $100, and the price of the bike in Europe is €125. Therefore, the purchasing power parity theory would predict that the dollar/euro exchange rate should be $1 = €1.25.

A Base Model Schwinn Bike Costs $100 in the United