If one kilogram of flour costs $2 in Canada, and 100 shillings in Kenya, what would Purchasing Power Parity predict the Kenyan shilling to be worth in Canadian
dollars?
To predict the value of the Kenyan shilling in Canadian dollars using Purchasing Power Parity (PPP), we need to compare the cost of a representative basket of goods in both countries. In this case, we will consider the price of one kilogram of flour.
First, we calculate the exchange rate based on the relative prices of flour in both countries. Let's assume Purchasing Power Parity holds, meaning that the relative cost of goods should be equal in both countries.
The cost of one kilogram of flour is $2 in Canada and 100 shillings in Kenya. Therefore, using the PPP principle, the exchange rate between the two currencies can be calculated by dividing the price in one currency by the price in the other currency.
Exchange rate = Price in one currency / Price in the other currency
In this case, it would be:
Exchange rate = $2 / 100 shillings
By simplifying this ratio, we find that the exchange rate would be 1 Canadian dollar = 50 Kenyan shillings.
Therefore, Purchasing Power Parity predicts that one Kenyan shilling would be worth 0.02 Canadian dollars (1/50) based on the price of flour.