Question

1.

a.Suppose that the consumer price index P=120, the annual growth rate in money demand is 3%, and the annual change in money supply is 400 dollars. If the current money supply is 5,000 dollars. Find the change in consumer price index ( ΔP)?

b.If the price of a car in the U.S is 8,000 $, and in Japan the same car costs 870,000 Japanese yen ¥. Find the exchange rate under the purchasing power parity (PPP)? That is you need to find how many U.S. dollars can be purchased in one Japanese yen and vice versa.

Answer 1

Answer (a): The Consumer Price Index is calculated by diving the total increases or decreased price of goods and services in the current year by the price of goods and services in the base year, and then multiplying it by the base year consumer price index. Here in the base year the price of goods and services is given as 5000, the base consumer price index is given by 120, it is further given that the total increase in the price of goods and services has risen by $400, which means that the price of goods and services in the current year is ($5000 + $400) = $5400. Therefore, the Consumer Price index in the current year would be:

                               CPI = (5400 / 5000) x 120

                                      = 1.08 x 120

                                      = 129.6

               Hence, the Consumer Price Index in the current year is 129.6.

Answer (b): If the price of a Car in the US is 8000 and the price of the same Car is Japan is 870,000 Japanese Yen, this would mean that the exchange rate under the purchasing power parity would be:

                                        870,000 / 8000

                                     = 108.75

I.e. 108.75 Japanese Yen can be purchased by $ 1

& (1/108) = $ 0.0091 can be purchased by the 1 Japanese Yen.