If P = domestic prices, P* = foreign prices, and e is the nominal exchange rate, which of the following is implied by purchasing-power parity?
A)P = e/P*
B)1 = e/P*
C)e = P*/P
D)P/P*=1

Question

Quizplus · Accepted Answer

Purchasing-power parity implies that the exchange rate should fully adjust to equalize domestic and foreign prices. This can be expressed mathematically as e = P*/P or equivalently as P/P* = e. Therefore, choice C, e = P*/P, is the correct implication of purchasing-power parity.

If P = Domestic Prices, P* = Foreign Prices, and E