Answer (D) is correct . Inflation in the U.S. means that $1.05 now has the purchasing power formerly enjoyed by $1.00. The 10% depreciation of the euro means that its purchasing power in dollars has declined to 90%. Dividing the U.S. inflation factor of 1.05 by the new euro value of .90 and subtracting 1 results in a net loss of euro purchasing power against the dollar of 16.67%.
Answer (A) is incorrect because The euro’s loss of purchasing power through depreciation against the dollar outweighs the dollar’s loss of purchasing power against all other currencies due to inflation. Thus, euro costs will increase, not decrease.
Answer (B) is incorrect because The euro’s loss of purchasing power through depreciation against the dollar outweighs the dollar’s loss of purchasing power against all other currencies due to inflation. Thus, euro costs will increase, not decrease.
Answer (C) is incorrect because This percentage is the difference between the currency depreciation and the inflation rate.
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