Question

The nominal exchange rate is .80 euros per U.S. dollar and a basket of goods in France costs 1,000 euros while the same basket costs $800 in the U.S. The nominal exchange rate is 1.2 Australian dollars per U.S. dollar and a basket of goods in Australia costs 960 Australian dollars while the same basket costs $800 in the U.S.. Which country has purchasing-power parity with the U.S.?

Answer 1

Answer:

Australia has purchasing-power parity with the U.S.

Explanation:

A basket of goods costs $800 in the US. The same basket costs 1,000 euros in France and 960 Australian dollars in Australia.  

The nominal exchange rate for euros is .80 euros per U.S. dollar and for Australian dollars, it is 1.2 Australian dollars per U.S. dollar.  

The purchasing power parity theory compares the currency of two countries through a basket of goods. The currency of the two countries is in equilibrium or is at par if a basket of goods cost the same in both the countries.  

This method compares the economic productivity and standard of living in two countries.  

Converting the value of basket in France into US dollars,

= $\frac{1,000}{0.80}$

= $1,250  

Converting the value of basket in Australia into US dollars,

= $\frac{960}{1.2}$

= $800

The cost of the basket of goods is same in Australia. This indicates that Australia has purchasing-power parity with the U.S.