Question

Suppose that the current Canadian dollar (CAD) to U.S. dollar exchange rate is \(0.85 CAD = \)1 U.S. and that the U.S. dollar price of an iPhone is \(300. What is the Canadian dollar price of an iPhone? Next, suppose that the CAD to U.S. dollar exchange rate moves to \)0.96 CAD = $1 U.S. What is the new Canadian dollar price of an iPhone? Other things equal, would you expect Canada to import more or fewer iPhones at the new exchange rate? Explain.

Short answer

The price of an iPhone in Canadian dollars is $255 CAD.

The price of the iPhone in Canadian dollars at the new exchange rate is $288 CAD.

The imports of the iPhone in Canada will fall.

Step-by-step solution

Purchasing power parity

According to purchasing-power-parity theory, exchange rates should eventually adjust to equate the purchasing power of various currencies.Conversely, due to a change in exchange rates, countries' purchasing power for the same unit of goods varies.

In practice, however, exchange rates are often very slow to adjust to equate the purchasing power of various currencies and thereby take a long time to achieve "purchasing power parity."

Canadian dollar price at $0.85 CAD = $1 US

The price of an iPhone in U.S. dollars is $300. At the given exchange rate of $0.85 CAD = $1 U.S., the price of the iPhone in Canadian dollars will be:

$$\begin{gathered} 1\mathrm{US}=0.85\mathrm{CAD} \\ 300\mathrm{US}=0.85\times 300 \\ =\$255\mathrm{CAD} \end{gathered}$$

The price of an iPhone in Canadian dollars is $255 CAD.

Canadian dollar price at $0.0.96 CAD = $1 US

The exchange rate between Canada and the U.S. has changed due to the appreciation of U.S. dollars. At the new exchange rate of $0.96 CAD = $1 U.S., the price of the iPhone in Canadian dollars will be

$$\begin{gathered} 1\mathrm{US}=0.96\mathrm{CAD} \\ 300\mathrm{US}=0.96\times 300 \\ =\$288\mathrm{CAD} \end{gathered}$$

The price of an iPhone in Canadian dollars is $288 CAD.

Effect on Canadian imports

Since the value of Canadian dollars has depreciated (appreciation of U.S. dollars), it has become costly to purchase the iPhone from the U.S. Thus, imports of the iPhone in Canada will fall.