Question 4 (20 points): The starting point for understanding how exchange rates are determined is a simple idea called the law of one price.

a. Suppose that a laptop costs 1,000 dollars in the United States and 800 euros in the Eurozone. If absolute PPP holds, and Europe and the United States trade only laptops, what is the dollar-euro exchange rate?

b. Due to changes in demand, the price of a laptop in the United States increases to 1,200 dollars. If absolute PPP holds, what happens to the exchange rate? Which currency appreciate? And by how many percent?