Question

22) One year ago the spot rate of U.S. dollars for Canadian dollars was $1/C$1. Since that time the rate of inflation in the U.S. has been 4% greater than that in Canada. Based on the theory of Relative PPP, the current spot exchange rate of U.S. dollars for Canadian dollars should be approximately ________. A) $0.96/C$ B) $1/C$1 C) $1.04/C$1 D) relative PPP provides no guide for this type of question

Answer 1

According to the theory of Relative Purchasing Power Parity, if the U.S. inflation rate is 4% higher than Canada's, the U.S. dollar should depreciate by that amount. Thus, the current exchange rate should be approximately $0.96/C$1.

Step-by-step explanation:

The theory of Relative Purchasing Power Parity (PPP) suggests that the change in the nominal exchange rate between two countries' currencies over a certain period should be equal to the difference in the countries' inflation rates over the same period. If the inflation rate in the U.S. has been 4% greater than that in Canada over the last year, and if one year ago the spot exchange rate was $1/C$1, then according to Relative PPP, the U.S. dollar should have depreciated by approximately 4% against the Canadian dollar. Hence, the current exchange rate should be approximately $0.96/C$1, as the U.S. dollar would now buy 4% less Canadian currency.

Answer 2

Answer: C) $1.04/C$1

Step-by-step explanation:

We define the inflation rate in a certain country as

• a rate at which the value of a currency is falling
• as a result the usual level of prices for goods and services keeps rising.

1 year ago the spot rate of U.S. dollars for Canadian dollars was $1/C$1.

That time inflation rate in US was 4% greater than in Canada.

So, the current spot exchange rate of U.S. dollars for Canadian dollars :

($1 + 4% of $1)/C$1

=($1+$0.04)/ C$1

=$1.04 / C$1

Hence, the correct option is C) $1.04/C$1