Question

If the price level recently increased by 20% in England while falling by 5% in the United States, how much must the exchange rate change if PPP holds? Assume that the current exchange rate is 0.55 pounds per dollar.

Answer 1

Answer:

£.0.6875 per USD

Explanation:

PPP stands for purchasing power parities. It is actually the rate of currency conversion.

As per the given information, the price level recently increased by 20% in England while falling by 5% in the United States, so the net increase in the U.S. dollar would be (20+5)=25%.

This can be taken as that now 20% more pounds shall be needed to purchases the same U.S. goods.

Hence the new exchange rate would be:

= 1.25 x £0.55/$1 = £.0.6875 per USD