If the U.S. price level is increasing by 3 percent annually and the Swiss price level is increasing by 2 percent annually, by about what percent would the price of a dollar in terms of Swiss francs need to change according to purchasing power parity?
A)decrease by 5 percent
B)decrease by 1 percent
C)increase by 5 percent
D)increase by 1 percent

Question

Quizplus · Accepted Answer

Purchasing power parity (PPP) suggests that the exchange rate between two currencies should adjust to offset differences in inflation rates between the two countries. In this case, since the U.S. inflation rate is higher than Switzerland's, the dollar should depreciate relative to the Swiss franc to maintain PPP.

To calculate the expected change in the exchange rate, we take the difference in inflation rates and adjust for PPP.

(3% - 2%) / (1 + 2%) = 0.0098

This suggests that the dollar should decrease in value relative to the Swiss franc by approximately 0.98%, or about 1%. Therefore, the correct answer is B, decrease by 1 percent.

If the US Price Level Is Increasing by 3 Percent Annually and Annually