Suppose a basket of internationally traded goods that sells for $10,000 in the United States sells for €8,000 in the euro zone.According to the purchasing power parity theory,the equilibrium exchange rate should be equal to _____.

Question

Quizplus · Accepted Answer

According to the purchasing power parity theory, the exchange rate should equalize the prices of the same basket of goods between different countries. In this case, the basket of goods costs $10,000 in the US and €8,000 in the euro zone. To find the equilibrium exchange rate, we need to convert €8,000 into dollars using the current exchange rate: 
€8,000 x 1.25 (current exchange rate) = $10,000 
Thus, the equilibrium exchange rate should be $1.25 per euro.

Suppose a Basket of Internationally Traded Goods That Sells for $10,000