The Open Economy — End of Chapter Problem
Suppose that purchasing-power parity holds between the United States and Mexico. A cup of coffee costs $4 in Austin, Texas, and 32 pesos in Mexico City.
a. Calculate the exchange rate in pesos per dollar.
The exchange rate is ______ pesos per dollar.
b. Mexico experiences inflation of 50 percent, and the United States experiences inflation of 100 percent.
The price of a cup of coffee is now ________ dollars in Austin.
The price of a cup of coffee is now _________ pesos in Mexico City.
c. Calculate the new exchange rate in pesos per dollar.
The new exchange rate is ________ pesos per dollar.
d. This numerical example illustrates the principle that countries with higher inflation experience currency (depreciation / appreciation)