The inflation rate in the United States is 3 percent while the inflation rate in Japan is 10 percent. The current exchange rate for the Japanese yen (¥) is $0.0075. aFter supply and demand for the Japanese yen have adjusted in the manner suggested by purchasing power parity, the new exchange rate for the yen will be:

Question

Quizplus · Accepted Answer

According to the purchasing power parity (PPP) theory, the exchange rate adjusts so that the same goods cost the same in both currencies when measured in a common currency. Given that the inflation rate in the United States is 3% and in Japan is 10%, the Japanese yen should depreciate relative to the US dollar. The expected depreciation can be calculated as: (1 + inflation rate of foreign country) / (1 + inflation rate of home country) = (1 + 0.10) / (1 + 0.03) = 1.10 / 1.03 ≈ 1.06796. The initial exchange rate is $0.0075, so the new exchange rate should be $0.0075 / 1.06796 ≈ $0.0070, which matches option C.

The Inflation Rate in the United States Is 3 Percent