Consider two open economies A (national) and B.
In this economy only one good is produced for time t = 0 and price P(0,A)=1 Dollar and P(0,B) = 1,5 Euro. The nominal exchange rate for that time is E(0)=1,5 Euro/Dollar.
Country A has inflation of (A) = 10%
Country B has inflation of (B) = 5%
To which value the nominal exchange rate turns itself at time t = 1, assuming we have the absolute (Purchasing Power Parity)?
1) E(1) = 0.75Euro/Dollar
2) E(1) = 0.70Euro/Dollar
3) E(1) = 3Euro/Dollar
4) E(1) = 1,43Euro/Dollar
5) E(1) = 1Euro/Dollar
Please show the way to calculate it.© BrainMass Inc. brainmass.com October 10, 2019, 2:07 am ad1c9bdddf
If inflation in A is 10%, then at t = 1, the price of the good in A will be 1*1.1 = $1.1. Thus, the new price is a 10% increase over the old price of $1.
Exchange Rate is integrated in this solution.