The American Shopper in Japan

Answer the following questions to check your understanding of the story.

What is the approximate market exchange rate for yen per U.S. dollar used by New Yorker Jen Caramichael?

a) 0062

b) 162

c) 120

d) 74

Wrong! - At the market exchange rate, 120,000 yen is worth about $740. How many yen does one U.S. dollar buy?

You Got It! - At the market exchange rate, 120,000 yen is worth about $740, so one U.S. dollar buys approximately 162 yen. (120,000 ÷ $ 740)

How many U.S. dollars would Jen Caramichael spend on the Seiko watch in each country?

a) $740 in both countries

b) $1,000 in both countries

c) $740 in Tokyo and $1,000 in New York

d) $1,000 in Tokyo and $740 in New York

Wrong! - At the market exchange rate, 120,000 yen is equivalent to approximately $740, so what is the price of a Seiko watch in Japan? What is the price in the United States? Are the prices the same in both countries?

Well Done! - At the market exchange rate, 120,000 yen is equivalent to approximately $740, so Jen would spend about $740 in Tokyo. The same watch costs about $1,000 in New York.

What is purchasing power parity (PPP)?

A situation in which prices of identical tradable goods _________ when converted at the market exchange rate.

a) in two countries are equal

b) in two countries are different

c) are lower in poorer countries

d) are higher in richer countries

Wrong! - PPP predicts equal prices, and is not based on a country's income.

Good Job! - PPP states that identical goods should sell for the same price once prices are converted into a common currency using the market exchange rate.

If the prices of all goods and services are like the prices of a Seiko watch, is the U.S. dollar overvalued or undervalued relative to yen?

The U.S. dollar is __________ relative to yen because one U.S. dollar buys __________ yen in the market than purchasing power parity suggests.

a) undervalued; more

b) overvalued; fewer

c) overvalued; more

d) undervalued; fewer

Wrong! - One U.S. dollar buys more yen in the market than PPP suggests. So is the U.S. dollar overvalued or undervalued relative to then yen?

Correct! - Assuming the retail price of the Seiko watch is representative of all goods and services, PPP implies that one U.S. dollar buys 120 yen (120,000 divided by 1000), but in the market it buys about 162 yen, so the U.S. dollar is overvalued.

Is comparing the retail prices of a Seiko watch in Tokyo and New York City an accurate test of purchasing power parity (PPP), and is the conclusion drawn in Question 7 necessarily correct?

No! The higher retail price of the Seiko watch in New York may reflect __________ local retail costs rather than an __________ dollar.

a) higher; undervalued

b) higher; overvalued

c) lower; overvalued

d) lower; undervalued

Wrong! - Under the assumptions of Question 7, the U.S. dollar is overvalued. But the higher retail price may simply reflect higher retail costs.

That's Right! - PPP applies to tradable goods, but a Seiko watch's retail price includes non-tradable retail services. So, the higher U.S. retail price may simply reflect higher retail costs in New York, not an overvalued U.S. dollar.

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