The theory that exchange rates are related to difference in the level of prices between countries is known as:
A) contagion.
B) exchange rate regime.
C) purchasing power parity.
D) law of two prices.
E) relative parity.

Question

Quizplus · Accepted Answer

The theory of purchasing power parity (PPP) states that exchange rates between two countries should equalize the price levels of a basket of goods and services in each country. In other words, if a particular set of goods costs less in one country relative to another country, then the exchange rate between those two countries should adjust accordingly to reflect the difference in prices. This theory assumes that there are no transaction costs or barriers to trade between the two countries.

The Theory That Exchange Rates Are Related to Difference in the Level