Question

If the 2018 inflation rate in Britain is 2.3 percent, and the inflation rate in the U.S. is 1.8 percent, then the theory of purchasing power parity predicts that, during 2018, the value of the British pound in terms of U.S. dollars will :

rise by 0.5 percent.

fall by 0.5 percent.

fall by 1 percent.

rise by 1 percent.

Answer 1

The change in the value of the British pound = (1 + inflation in the U.S.)/(1 + inflation in the U.K.) - 1

Note that we have U.K. inflation in the denominator as we are interested in the value of the British Pound.

The change in the value of the British pound = (1 + 0.018)/(1 + 0.023) - 1 = -0.004887585533

The change in the value of the British pound = -0.4887585533%

The change in the value of the British pound ~ -0.5%

fall by 0.5 percent

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