If a basket of goods in the United States costs $1,000 and the same basket of goods in Japan costs ¥125,000, then for PPP to exist, $1 should trade for ____ Japanese yen.

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BlackTom AI · Accepted Answer

To evaluate PPP (purchasing power parity) in this scenario, compare the cost of the same basket of goods in both currencies.

First, note the US price: $1,000 for the basket. In Japan, the same basket costs ¥125,000.

PPP implies that the amount of yen you need to buy the basket should equal the dollar price converted by the PPP exchange rate, i.e., the rate at which dollars can be exchanged for yen so that the purchasing power is identical in both countries.

Compute the implied exchange rate by dividing the Japanese price by the American price: ¥125,000 ÷ $1,000 = ¥125 per $1. This is the rate that would equalize the cost of the basket across the two countries under PPP assumptions.

Now evaluate each option:
- Option 4: 4 — This would imply that $1 buys only 4 yen, which would make the Japanese basket far cheaper in yen terms than in dollars and would not align with the given prices. The calculated PPP rate is far larger than 4, so this is inconsistent.
- Option 50 — This suggests $1 equals 50 yen. While closer than 4, it still does not match the ratio of ¥125,000 to $1,000, which is 125 yen per dollar. Hence this is not the PPP rate for these baskets.
- Option 125 — This matches the computed PPP rate, since ¥125,000 ÷ $1,000 = ¥125 per $1. At this rate, the cost of the basket in dollars would equate to the cost in yen when converted, satisfying PPP conditions for these prices.
- Option 125,000 — This would imply $1 buys 125,000 yen, which would drastically overstate the value of the dollar relative to the yen given the basket prices, and is not supported by the price comparison.

In summary, PPP requires the exchange rate that equates the relative cost of the identical baskets, which is obtained by dividing the Japanese price by the US price. The calculation yields ¥125 per $1, making option 125 the rate that would satisfy PPP for these figures. This reasoning shows why the other options fail to align the two price levels.

01:220:300:01 INTERNATIONAL ECON PPP, inflation, and FX practice questions (not for credit)

If a basket of goods in the United States costs $1,000 and the same basket of goods in Japan costs ¥125,000, then for PPP to exist, $1 should trade for ____ Japanese yen.

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