Suppose the exchange rate between the U.S.dollar and the Japanese yen is initially 90 yen per dollar.According to purchasing-power parity, if the price of traded goods rises by 10 percent in the United States and remains constant in Japan, then the exchange rate will become
A) 72 yen per dollar.
B) 81 yen per dollar.
C) 99 yen per dollar.
D) 108 yen per dollar.

Question

Quizplus · Accepted Answer

Purchasing-power parity suggests that eventually the exchange rate should adjust so that goods cost the same in both countries. If the price of traded goods in the U.S. rises by 10%, U.S. goods will now cost 10% more, so Americans will need to trade more dollars for the same amount of yen. This will cause a decrease in demand for dollars and an increase in demand for yen, causing the exchange rate to shift towards the equilibrium point where the yen is relatively more expensive. The new exchange rate will be 81 yen per dollar.

Suppose the Exchange Rate Between the U