A country has a relatlvely high rate of inflation. What does the Purchaslng Powe

Question

A country has a relatlvely high rate of inflation. What does the Purchaslng Power Parlty Theory tell us about this country in terms of inflation's impact on its currency and the resulting effect on the: (one sentence maximum cach) 1. Its currency value in foreign exchange: Volume of Import Trade into this country: Volume of Export Trade from this country Two countries, Poland and the US produce just one product: mutton meat. Suppose that the price of mutton in the US is $2.80 per pound, and in Poland it is Euro 3.70 per pound 2. According to PPP theory, what should the spot exchange rate be for? (test your answer to see if it makes sense) a) Ans.1S EuroShow why: Suppose the price of mutton is expected to rise to $3.10 in the US, and to Euro 4.60 in Poland. What should be the one year forward rate be for the two currencies? b) Ans. 1 Euro Show why:

Explanation / Answer

1) The PPP theory tells us about the exchange rate and a way to compare the average costs of goods and services between countries . As for example : Price of a car in USA = 100$ . Price of the same car in India = Rs. 200 . Then by PPP : 1$ = Rs. 2

If there is relatively higher inflation in USA , then price of car rises from 100 to 150 $ suppose .

So now 1$ = Rs. 1.33 ( we get less rupees with one dollar than before )

Its currency value in foreign exchange depreciates

When the dollar depricistes ,

Volume of imports falls . Volume of exports rise .

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