Suppose the dollar-pound rate equals $0.5 per pound. According the purchasing power parity theory, what will happen to the dollar's exchange rate under each of the following scenarios ?
a) The U.S. price level increases by 10% and price level in Britain stays constant
b) The U.S. price level increases by 10%, while price level in Britain increases 20%
c) The U.S. price level increases by 10%, while price level in Britain increases by 5%
The response addresses the queries posted in 552 words with references.
// In order to start with such kind of paper, first, we must familiarize with the concept of 'Purchasing Power Parity'. Here, the different values of the dollar pound rate are given. We have to write about the dollar exchange rate in three conditions, as per the 'Purchasing Power Parity Theory. But initially, we must describe the theory in brief, like this//
Purchasing Power Parity Theory
According to the theory of purchasing power parity (PPP), when the purchasing power of two countries is same, then there is equilibrium in exchange rates between their currencies. In other words, the rate of exchange between two nations should be equivalent to the ratio of the price level of a fixed basket of goods and services of the two countries. When a country is experiencing inflation I.e. When its domestic ...
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