Let us consider a Utopian world in which there are only three goods: sake, beer, and TV sets.
■ Japanese consume only a locally produced food, called sake, and an industrially produced and traded good, called TV sets.
■ Americans consume only a locally produced food, called beer, and an industrially produced and traded good, called TV sets.
TV sets are produced in both countries and actively traded; their local prices follow the law of one price. Foods are produced only locally and are not traded. The consumption basket of a Japanese individual consists of two-thirds sake and one-third TV sets. The consumption basket of an American consists of one-half beer and one-half TV sets. Prices of beer and TV sets in the United States are constant over time in U.S. dollars. Japanese are very competitive and export a lot of TV sets. Japanese fanners want to share in the increased national wealth, and the price of sake is rising at a rate of 10 percent per year in yen. Assume that the yen/dollar exchange rate stays constant.
a. What is the consumer price index inflation in Japan?
b. Does relative PPP hold between Japan and the United States?