Question

Toyota's Pass-Through. Assume that the export price of a Toyota Corolla from Osaka, Japan, ís ¥2.100.000. The exchange rate is ¥87.6215. The forecast rate of inflation in the United States is 2.2% per year and in Japan it is 0.0% per year. Use this data to answer the following questions on exchange rate pass through a. What was the export price for the Corolla at the beginning of the year expressed in U.S. dollars? b. Assuming purchasing power parity holds, what should be the exchange rate at the end of the year? C. Assuming 100% exchange rate pass-through, what will be the dollar price of a Corolla at the end of the year? d. Assuming 75% exchange rate pass-through, what will be the dollar price of a Corolla at the end of the year?

Answer 1

US Inflation Rate = 2.2 % and Japanese Inflation Rate = 0 %

Japanese Price = 2100000 Yen and Current Spot Rate = 87.62 Yen / $

(a) Initial Export Price in $ = 2100000 / 87.62 = $ 23967.1

(b) If Purchasing Power Parity (PPP) holds, then expected exchange rate one year from now = 87.62 x [1+0.022/1+0] = 89.5476 Yen / $

(c) Exchange Rate Pass through(ERPS) is given by the following formula:

ERPS = % Change in Price / % Change in Exchange Rate. In othe words, ERPS is a measure of the change in price for a unit % change in exchange rate

% Change in Exchange Rate = 1.022 or 2.2 %

ERPS = 100%

Therefore, New Export Price in Yen = 2100000 x 1.022 = 2146200 Yen

Export Price in $ = 2146200 / 89.5476 = $ 23967.1

ERPS = 75 %

Therefore, % Change in Price = 0.75 x 2.2 = 1.65 %

New Export Price in Yen = 1.0165 x 2100000 = 2134650

Export Price in $ = 2134650 / 89.5476 = $ 23838.2

Answer 2

The answer is wrong, US has higher inflation, no way the expected new spot rate one year from now goes higher