Question

Suppose a year ago the exchange rate between Mexican pesos and dollars was 13.5 pesos per dollar, and that according to relative PPP the exchange rate was in equilibrium. Furthermore, assume that since then, Mexican inflation has been 10% while the U.S. inflation has been 3%. If according to relative PPP the peso is now said to be overvalued, what is a possible exchange rate (of pesos per dollar) consistent with this assertion? Select all that apply 10 11 12 13 14 15 16 17

Answer 1

Correct option is E.

14 pesos per dollar

Step-by-step explanation:

The exchange rate between Mexican pesos and dollars was 13.5 pesos per dollar.

According to the relative Purchasing Power Parity (PPP), the exchange rate was in equilibrium. But now,

Mexican inflation = 10%

U.S inflation = 3%

Now the Mexican peso is overvalued by = 10% - 3% = 7%

So, the possible increase in exchange rate (of pesos per dollar) considered with this assertion is = Exchange rate of pesos per dollar * Inflation rate

= 13.5 * 7%

= 13.5 * 7/100

= 0.945

The possible in exchange rate = Previous Exchange rate + Increase in exchange rate

= 13.5 + 0.945

= 14.445

= 14.4 (rounding off)

=14