Suppose the current exchange rate between the U.S.dollar and the Mexican peso is $0.12 = 1 peso.Furthermore,suppose the price level in the United States rises 25 percent at a time when the Mexican price level is stable.According to the purchasing power parity theory,what will be the new equilibrium exchange rate?

Question

Quizplus · Accepted Answer

When the price level in the United States rises by 25% while the Mexican price level remains stable, the value of the U.S. dollar in terms of pesos will decrease to maintain purchasing power parity. The original exchange rate is $0.12 = 1 peso. A 25% increase in the U.S. price level implies that the new exchange rate needs to adjust so that the same amount of goods can be bought for the new amount of dollars. Therefore, $0.12 + (25% of $0.12) = $0.12 + $0.03 = $0.15 = 1 peso.

Suppose the Current Exchange Rate Between the U