Suppose the price of a mobile phone in Australia is $400 and 30 000 yen in Japan. If the current exchange rate is 100 yen to the dollar, then purchasing power parity theory would predict that in the long run:
A)the yen will depreciate relative to the dollar.
B)the yen will appreciate relative to the dollar.
C)the value of the yen relative to the dollar will not change.
D)both the yen and the dollar will appreciate.

Question

Quizplus · Accepted Answer

According to purchasing power parity theory, exchange rates should adjust so that the same goods in different countries have the same price in the long run. Thus, the price of the mobile phone in Japan should eventually be equal to its price in Australia (assuming no trade barriers). Currently, the phone costs 30,000 yen, which is equivalent to $300 at the current exchange rate. Since this is less than the price in Australia ($400), the theory predicts that the yen will appreciate (i.e. become stronger) relative to the dollar, making the phone more expensive in Japan and reducing the price difference between the two countries.

Suppose the Price of a Mobile Phone in Australia Is