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International Finance for West German and U.S. Price Levels

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1. From base price levels of 100 in 1987, West German and U.S. price levels in 1988 stood at 102 and 106, respectively. If the 1987 $/DM exchange rate was $0.54, what should the exchange rate be in 1988? In fact, the exchange rate in 1988 was DM 1 = $0.56. What might account for the discrepancy? (Price levels were measured using the consumer price index.)

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ANSWER. If e1981 is the dollar value of the German mark in 1988, then according to purchasing power parity e1988/.54 = 106/102 or e1988 = $.5612. The discrepancy between ...

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