One year ago the spot rate of U.S. dollars for Canadian dollars was $1/C$1. Since that time the rate of inflation in the U.S. has been 4% greater than that in Canada. Based on the theory of Relative PPP, the current spot exchange rate of U.S. dollars for Canadian dollars should be approximately:

Question

Quizplus · Accepted Answer

According to the theory of Relative Purchasing Power Parity (PPP), the change in the exchange rate between two currencies over a period of time should approximately equal the difference in inflation rates between the two countries. If the U.S. inflation rate is 4% higher than Canada's, the value of the U.S. dollar should decrease relative to the Canadian dollar. Therefore, it would now take more U.S. dollars to purchase 1 Canadian dollar, making the correct answer $1.04/C$, as the U.S. dollar has depreciated by approximately 4%.

One Year Ago the Spot Rate of U