You work for a company that conducts business with Japan and current
economic environment is as explained below.
The inflation rate in the U.S. and Japan are 4% and 2%, respectively
and the current spot rate is $.0083333 per one Japanese yen or 120
Japanese yen per one U.S. dollar. How much does the U.S. dollar have
to depreciate in order to maintain purchasing power parity? Be sure to
show your calculations.
Note: I need at least 2 pages in length (If possible).

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Request for Question Clarification by paul_b_18-ga on 08 Apr 2004 07:23 PDT

Hi,

I can give you the calculations and the answer. I can also give you an
explanation. However, I can't give you an answer which has a length of
two pages.
Would you be satisfied with an answer with the above mentioned
elements, but which is much shorter than two pages?

Please let me know as I'm sure I can help you.

Thanks,
paul_b_18

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Clarification of Question by jara6650-ga on 08 Apr 2004 08:10 PDT

Yes, That's fine. Thank you.

Hi,
In the original situation in your case 1 dollar equals 120 yen. This
means the exchange rate between the US and Japan is 0.0083333333
USD/Yen.
 
The ?Dictionary of Economics? gives the following definition of
Purchasing Power Parity: ?A theory which states that the exchange rate
between one currency and another is in equilibrium when their domestic
purchasing powers at that rate of exchange are equivalent.?
Source: About.com
http://economics.about.com/cs/money/a/purchasingpower.htm
 
This means that a certain good should cost the same in Canada and the
United States once you take the exchange rate into account.
 
Suppose a hamburger costs 1 dollar in the US, then that same hamburger
will cost 120 yen in Japan in the original situation (where we have
PPP). Here then we have a ratio of 1:120 for the price of the
hamburger.
At that moment the inflation rate in the US is 4 % and the inflation
rate in Japan is 2 %. This means that the hamburger in the US will
rise in price to 1 x 1.04 = 1.04 dollar and that same hamburger in the
Japan will rise in price to 120 x 1.02 = 122.4 yen.
We then have a ratio 1.04 to 122.4 for the price of the hamburger.
Considering the exchange rate of 0.0083333333 USD/Yen, there no longer
is Purchasing Power Parity.
 
If want to retain Purchasing Power Parity, we need to get the ratio of
1 x 120 for the price of the hamburger (because it should equal the
ratio of the exchange rate).
The price of the hamburger should be 122.4 / 120 = 1.02 dollar.
In order to achieve this ratio the dollar will have to depreciate 100
? (1.02 / 1.04 ) = 0.0192307692 % or 0.02 cents.
 
More information about the Purchasing Power Parity theory can be found here:
 
1. ?Wikipedia.org?
http://en.wikipedia.org/wiki/Purchasing_power_parity
 
2. ?About.com?
http://economics.about.com/cs/money/a/purchasingpower.htm
 

Search strategy:
Google: "purchasing power parity"
 
I hope you have enough information. If you need any more, please ask
for a clarification!
 
Thank you,
paul_b_18

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Request for Answer Clarification by jara6650-ga on 08 Apr 2004 14:44 PDT

Hello paul_b_18-ga

I have another question posted under the "Doing Business with Japan"
title. Can you work this one too. Please let me know. Thanks.

jara6650

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Clarification of Answer by paul_b_18-ga on 08 Apr 2004 15:51 PDT

Hi,

Of course I am willing to help you with another question!
However, as with your last question I need to know if the answer may
be substantially shorter than two pages. If you found my previous
answer long enough, please let me know and I will start working on it
straight away!

Thanks for your tip and rating by the way!
paul_b_18

paul_b_18-ga

Thank you so much for your answer to my question. I look forward to
have you work another one of my situations. Have a great day. 
jara6650