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Chapter 5: Q3BP (page 681)

From the base price level of 100 in 1979, Saudi Arabian and U.S. price levels in 2008 stood at 200 and 410, respectively. If the 1979 \(/riyal exchange rate was \)0.26/riyal, what should the exchange rate be in 2008? Suggestion: using purchasing power parity, adjust the exchange rate to compensate for inflation. That is, determine the relative rate of inflation between the United States and Saudi Arabia and multiply this times $/riyal of 0.26.

Short Answer

Expert verified

$0.533 per riyal

Step by step solution

01

Purchasing power parity- definition

Purchasing power parity theory states that the equilibriumrate of exchange is determined by the equality of the purchasing power of two inconvertible currencies

02

Calculation of relative rate of inflation

Relativerateofinflation=U.S.pricelevel(2008)SaudiArabiapricelevel(2008)=410200=$2.05perriyal

03

Calculation of exchange rate in 2008

Exchangeratein2008=Relativerateofinflation×Exchangeratein1979=2.05×0.26=$0.533/riyal

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