Question

Assume that the USD/JPY exchange rate is 108.58. Which one of the following concepts supports the idea that an item that sells for 500 U.S. dollars in the U.S. is currently selling in Japan for 54,290 Japanese yen?

Group of answer choices

Interest rate parity

Absolute purchasing power parity

International fisher effect

Uncovered interest rate parity

Unbiased forward rates condition

Answer 1

Solution :

The absolute purchasing power parity concept, two currencies are said to be at par when the price of a product is Country A is equal to the price of the product in Country B, based on the exchange rate.

As per the Absolute Purchasing power parity formula

Exchange Rate (A / B) = ( Purchasing Power in Country A / Purchasing power in Country B )

= ( Purchasing Power in Currency A / Purchasing power in Currency B )

As per the Information given in the question we have

Currency A = Japense Yen ; Currency B = USD

Purchasing Power in Currency A ( JPY ) = Price of Product in Currency A =  JPY 54,290

Purchasing power in Currency B ( USD ) = Price of Product in Currency B = $ 500

Applying the above values in the formula we have the exchange rate between USD and JPY as:

= JPY 54,290 / USD 500

= JPY 108.58

This implies that 1 USD = JPY 108.58 which is the same as the exchange rate as per the information given in the question.

Thus it can be inferred that the Absolute Purchasing power Parity supports the idea that an item that sells for 500 U.S. dollars in the U.S. is currently selling in Japan for 54,290 Japanese yen

The solution is Option A : Absolute Purchasing power Parity