Answer (D) is correct . Assuming the original exchange rate is $1 to 2,000 lira and that U.S. inflation is 5%, the cost in lira to purchase what once cost $1 will now be 2,100 lira (2,000 ¡Á 1.05). However, if the lira also depreciates by 10%, the exchange rate will be $1 to 2,200 lira. At this rate, 2,310 lira (2,200 ¡Á 1.05) will be required to purchase $1.05. Lira costs will thus increase by just over 15% (310 ¡Â 2,000).<
Answer (A) is incorrect because The combined effect of U.S. inflation and the decline in value of the lira would cause the lira costs for U.S. imports to increase.
Answer (B) is incorrect because The combined effect of U.S. inflation and the decline in value of the lira would cause the lira costs for U.S. imports to increase.
Answer (C) is incorrect because Five percent is the difference between the currency depreciation and the inflation rate.
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