A car costs $20,000 in the United States and 2.500,000 yen in Japan. The exchange rate...

Question

Question

Answer 1

Answer #1

Purchasing power parity exchange rate is that exchange rate at which price of a good become identical in the two countries.

A car costs $20,000 in the United States and 2,500,000 yen in Japan.

The given exchange rate is $1 = 103 yen

At this exchange rate,

$20,000 = 20,000 * 103 = 2,060,000 yen

So,

At the given exchange rate, the value of $20,000 car in the United States should be 2,060,000 yen in Japan.

However, the car costs 2,500,000 in Japan.

So, exchange rate is not equating the value of good in two countries.

Calculate the purchasing power parity exchange rate -

Cost of car in United States = Cost of car in Japan

$20,000 = 2,500,000 yen

$1 = 2,500,000/20,000

$1 = 125 yen

So,

The purchasing power parity of the dollar is 125 yen.

Answer 2

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