1. Suppose that a Starbuck’s venti latte currently sells for $4.50 in the U.S. and SF4.00 in Switzerland. Make up a value for the exchange rate between the dollar and the Swiss franc (expressed as francs per dollar) that leaves the dollar undervalued on a Starbuck’s purchasing power parity basis. Then use your numbers to show that, at this exchange rate, it would be cheaper to purchase coffee in the U.S. than in Switzerland.
2. The current exchange rate between the Japanese yen and the U.S. dollar is 120 yen per dollar. At current prices, a basket of goods that costs $100 to produce in the U.S. would cost ¥11,000 to produce in Japan. Over the coming year, the inflation rate in Japan is expected to be -1%, while the inflation rate in the U.S. is predicted to be 2%. The speed of convergence in the real exchange rate to PPP is 50% per year.
A. What is the current real exchange rate between the two countries, expressed as the price of U.S. goods relative to (divided by) the price of Japanese goods?
B. Is the dollar overvalued or undervalued against the yen?
C. What do you predict the real exchange rate will be one year from now?
d. What do you predict the yen per dollar nominal exchange rate will be in one year?