While shopping in the Mexican market, you find that limes cost 11 pesos each. You remember that back home, they cost 80 cents each. If the purchasing power parity theory holds, the rate of exchange is

Question

Quizplus · Accepted Answer

According to the purchasing power parity theory, the exchange rate between two countries should be equal to the ratio of the price levels in the two countries. In this case, the price of a lime in Mexico is 11 pesos while in the US it is 80 cents.

If we assume that the price levels in the two countries are similar (which is the assumption of purchasing power parity theory), then the exchange rate should be:

11 pesos / 0.80 dollars = 13.75 pesos/dollar

or

1 dollar / 13.75 pesos = 0.073 or 7.3 cents/peso.

Therefore, the best choice is A.

While Shopping in the Mexican Market, You Find That Limes