Question

From the base price level of 100 in 1979, Saudi Arabian and U.S. price levels in 2008 stood at 310 and 632, respectively. Assume the 1979 $/riyal exchange rate was $0.70/riyal. Suggestion: Using purchasing power parity, adjust the exchange rate to compensate for inflation. That is, determine the relative rate of inflation between the United States and Saudi Arabia and multiply this times $/riyal of 0.70 points Skipped What should the exchange rate be in 2008?

Answer 1

The adjusted exchange rate in 2008 between the U.S. dollar and the Saudi riyal, based on purchasing power parity and relative inflation rates, should be approximately $1.42/riyal.

Step-by-step explanation:

The adjusted exchange rate in 2008 between the U.S. dollar and the Saudi riyal using purchasing power parity (PPP) would be $1.42/riyal. To calculate this, we start with the base price level of 100 in 1979 for both countries. By 2008, the price level for Saudi Arabia increased to 310, and for the U.S., it increased to 632. The rate of inflation for each country is calculated by dividing the price level in 2008 by the price level in 1979. For Saudi Arabia, the inflation rate is 310/100 = 3.1 times, and for the U.S., it is 632/100 = 6.32 times.

We then find the relative rate of inflation by dividing the U.S. inflation rate by the Saudi Arabian inflation rate: 6.32 / 3.1 = 2.04. This shows the U.S. dollar has inflated 2.04 times more than the Saudi riyal since 1979. To adjust the 1979 exchange rate of $0.70/riyal for inflation, we multiply it by the relative rate of inflation: $0.70 * 2.04 = $1.428. This suggests that the exchange rate in 2008, adjusted for the inflation difference using PPP, should be around $1.42/riyal.