Suppose the current exchange rate between the U.S.dollar and the Mexican peso is $0.10 = 1 peso.Furthermore,suppose the price level in the United States rises 15 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

According to the purchasing power parity theory, the exchange rate between two currencies should adjust to reflect changes in the relative price levels of the two countries. In this case, since the U.S. price level has increased by 15%, the exchange rate should adjust to reflect this increase in relative prices. Using the formula:
New exchange rate = (1 + US inflation rate) / (1 + foreign inflation rate) x old exchange rate

New exchange rate = (1 + 0.15) / (1 + 0) x 0.10 = 0.115 pesos per dollar

Therefore, the new equilibrium exchange rate is $0.115 = 1 peso, which corresponds to option D.

Suppose the Current Exchange Rate Between the U