$6.$ Purchasing power parity

The law of one price

The theory of purchasing power parity $($PPP$)$ states that in the long$-$run exchange rates between two countries adjusts so that the price of an identical good is the same when expressed in the same currency.

A pair of headphones costs $40\mathrm{.}11$ in England. The spot rate is currently $$1\mathrm{.}9956$ per pound.

Assuming that PPP holds true, what is the price of the pair of headphones in the United States?

$$84\mathrm{.}04$

$$80\mathrm{.}04$

$$20\mathrm{.}10$

$$23\mathrm{.}12$

Suppose the price of the pair of headphones in the United States was actually $$88\mathrm{.}04.$ Assuming no transaction costs, transportation costs, or import restrictions, what does PPP predict would happen to the demand for the pair of headphones in the United States?

The demand for the pair of headphones would increase in the United States.

The demand for the pair of headphones would decrease in the United States.