Suppose a car sells for $20,000 in the United States while the same car sells for 2.4 million yen in Japan. Which exchange rate is consistent with purchasing power parity?
A) ¥120 for US$1.
B) ¥ for US$120.
C) ¥20 for US$120.
D) ¥1 for US$20.

Question

Quizplus · Accepted Answer

The exchange rate that is consistent with purchasing power parity is the one that equalizes the prices of goods in the two countries. If we convert the price of the car in Japan from yen to dollars using the current exchange rate of approximately ¥110 for US$1, we get a price of approximately $21,818. This is higher than the price of the same car in the United States, suggesting that the yen is overvalued relative to the dollar. Using purchasing power parity, we would expect the exchange rate to be somewhere between ¥120 and ¥130 for US$1, which would make the price of the car in Japan roughly equal to its price in the United States. Thus, the best choice is A.

Suppose a Car Sells for $20,000 in the United States