Assume that the current dollar-euro exchange rate E is $1.32 dollars per euro. A wallet that costs $120 in the United States would cost 100 in the European Union. For the next year, inflation in the United States is expected to be 6% and the inflation in the European Union is expected to be 1%.

1: In the next year, what is the expected U.S. minus European inflation (pUS - pEUR)?

2: Let's say that 20% of the deviation from PPP (the difference between q and 1) is eliminated each year through gradual adjustment (arbitrage). If so, what would be the expected level of q one year from now?

3:Using your answer from number 2, what percentage will the dollar be undervalued versus the euro next year?What is the expected rate of change in q from this year to the next?

4:Using your answers from number 1 and 3, what is the expected rate of nominal depreciation for the dollarfor the coming year?