If the 2005 inflation rate in Britain is 6 percent,and the inflation rate in the U.S.is 4 percent,then the theory of purchasing power parity predicts that,during 2005,the value of the British pound in terms of U.S.dollars will

Question

Quizplus · Accepted Answer

According to the theory of purchasing power parity, the exchange rate between two currencies should adjust to compensate for inflation differentials. Therefore, if the inflation rate in Britain is 6 percent and the inflation rate in the U.S. is 4 percent, the British pound should depreciate by 2 percent against the U.S. dollar to maintain purchasing power parity. This means that the value of the British pound in terms of U.S. dollars will fall by 2 percent during 2005. Thus, the correct answer is D.

If the 2005 Inflation Rate in Britain Is 6 Percent,and