Part 1If the price level recently increased by 1616% in England while falling by 77% in the United States, what must be the new exchange rate if PPP holds? Assume that the current exchange rate is 0.540.54 pound per dollar.The new exchange rate must be [input]enter your response here pound per dollar. (Round your response to two decimal places.)

Question

Part 1If the price level recently increased by 1616​% in England while falling by 77​% in the United​ States, what must be the new exchange rate if PPP​ holds? Assume that the current exchange rate is 0.540.54 pound per dollar.The new exchange rate must be [input]enter your response here pound per dollar. ​(Round your response to two decimal​ places.)

BlackTom AI · Accepted Answer

To begin, I’ll restate the scenario and what PPP implies in this context. Purchasing Power Parity (PPP) suggests that exchange rates adjust so that a given basket of goods costs the same in both countries when priced in a common currency. Here, the problem provides changes in price levels in England and the United States and asks for the new pound-per-dollar rate that would maintain PPP, given a starting exchange rate.

First, identify the relative price level changes. England’s price level increases by 16%, which means the price level multiplier is 1.16. The United States’ price level falls by 7%, which means the US price level multiplier is 0.93 (since a 7% fall leaves 93% of the original price). These multipliers reflect how much prices change in each country.

Under PPP, the new exchange rate equals the old exchange rate multiplied by the ratio of the new price level in England to the new price level in the United States: E_new = E_old × (P_E_new / P_US_new).

Plug in the numbers: E_old = 0.54 pounds per dollar, P_E_new = 1.16, P_US_new = 0.93. Compute the ratio 1.16 / 0.93 ≈ 1.246. Multiply by the old rate: 0.54 × 1.246 ≈ 0.67284.

Rounding to two decimal places, the new exchange rate is 0.67 pounds per dollar.

To sanity-check, note that England’s prices rose relative to the US, so the pound should strengthen (i.e., more pounds per dollar) under PPP; the computed rate 0.67 is indeed higher than 0.54, consistent with PPP expectations given the price-level shifts.

If there were other answer choices, I would compare each one to these calculations: any option significantly different from 0.67 would be inconsistent with the PPP-adjusted ratio 1.16/0.93, while a value around 0.67 would align with the math above. In this problem, the key steps are identifying the correct price-level multipliers, forming the ratio, applying it to the initial exchange rate, and rounding appropriately.

Homework:Chapter 20 Homework

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