Suppose a basket of goods that costs $400 in the United States costs only £200 in Britain and the current exchange rate is $1/pound. According to the purchasing power parity theory, the equilibrium exchange rate should be higher than $1/pound. Why?
a. The basket could be purchased in Britain for £200 and sold in the United States for $400, and the $400 could be used to purchase £400 for a £200 profit.
b. The basket could be purchased in Britain for £200 and sold in the United States for $200, and the $200 could be used to buy £200, for a £500 profit.
c. The basket could be purchased in the United States for $400 and sold in Britain for £400, and the £400 could be used to buy $1,400, for a £1,000 profit.
d. The basket could be purchased in the United States for $200 and sold in Britain for £400, and the £400 could be used to buy $800, for a $400 profit.
e. The basket could be purchased in the United States for $200 and sold in Britain for £400, and the £400 could be used to buy $900, for a £500 profit.
A
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In a flexible exchange rate system, which of the following would NOT cause the U.S. dollar to depreciate relative to the British pound?
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