Question

A can of soda costs $0.75 in the United States and 12 pesos in Mexico.

a) What would the peso-dollar exchange rate be if purchasing-power-parity holds?

b) If monetary expansion caused all prices in Mexico to double so that soda rose to 24 pesos, what would happen to the peso-dollar exchange rate?

Answer 1

a) 16 pesos per dollar

b) 32 pesos per dollar

Step-by-step explanation:

If purchase-power parity holds, the exchange rate should guarantee that the can of sold would cost the same dollar amount both in the United States and in Mexico. The exchange rate is:

`R=(12/ pesos)/(\$0.75)\\R=(16/ pesos)/(\$)`

If the price of the soda doubles and the parity remains, the exchange rate also double:

`R'= 2*R\\R'=(32/ pesos)/(\$)`