A Japanese friend of yours tells you that \"traveling in the U.S. is much more e

Question

A Japanese friend of yours tells you that "traveling in the U.S. is much more expensive now than it was a years ago. Last year I needed to use about 100 Yen to buy one U.S. dollar, now I need to use 112 Yen to buy the same dollar!" If there is no change in prices in the two countries over this time period, is your friend right or wrong? How about if there is 10% inflation in the US, and 30% inflation in Japan over this period? Finally (with more realistic numbers), how about ifthere is 2% inflation in the US, and no inflation in Japan over this period? Please explain your answer carefully 1.

Explanation / Answer

The friend is wrong.

Money gets devalue because of inflation. Here the prices of two countries are unchanged; therefore, requiring more Yen for purchasing one dollar should not be there; such thing indicates devaluation of Yen; but, this is not possible since there is no price change.

In case of 10% and 30% inflation of the US and J respectively:

J has higher inflation rate than the US. Net inflation in J would be (30% - 10% =) 20%. It means Yen would devalue by 20%. In that case more Yen would be required for purchasing 1 US-dollar; it requires (100 × (1 + 0.20) =) 120 yen per US dollar.

In case of 2% and 0% inflation of the US and J respectively:

Net inflation = 0% - 2% = -2%. There is no inflation in J, rather deflation since the net inflation is negative. In such case, Yen would be required less for purchasing 1 US-dollar. Yen = (100 × (1 – 0.02) =) 98 per US dollar.

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