Assume the initial yen/dollar exchange rate to be 100 yen per dollar.If the U.S.inflation rate is 2 percent, and the Japanese inflation rate is 7 percent, then the exchange rate should move to 105 yen per dollar according to the purchasing-power-parity theory.

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According to the purchasing-power-parity (PPP) theory, if the U.S. inflation rate is lower than the Japanese inflation rate, the value of the yen should decrease relative to the dollar. This means more yen would be needed to buy a dollar. Starting from 100 yen per dollar, with U.S. inflation at 2% and Japanese inflation at 7%, the yen should depreciate more than to 105 yen per dollar to maintain purchasing power parity.

Assume the Initial Yen/dollar Exchange Rate to Be 100 Yen