solution

The current price level in the U.S. is $14,000 per consumption bundle, and £10,000 per consumption bundle in the U.K.. The spot rate is $1.65/£. The annual inflation rate is expected to be 2% in the U.S. and 5% in the U.K.

(1) Assume £ depreciates against dollar by 4% in the next year. Discuss with calculations: a. The impact on GBP’s purchasing power of U.S. goods in the next year b. The impact on GBP’s purchasing power of U.K. goods in the next year c. Which country’s competitiveness improves in the next year? Explain.

(2) If there is no change to the import/export between the U.S. and the U.K. at the end of the next year, then according to relative purchasing power parity, it means the value of USD will change by ___% in the next year (show calculations with your answer).

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