The PPP theory says that in the long run the exchange rate between two currencies should move toward __________ the cost in each country of an identical basket of internationally traded goods.

Question

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The PPP theory suggests that the exchange rate between two currencies should equalize the cost of an identical basket of internationally traded goods in each country. This means that if the cost of the basket is lower in one country relative to another, the exchange rate should adjust so that the currency of the lower-cost country depreciates and the currency of the higher-cost country appreciates. The ultimate goal is to eliminate any arbitrage opportunities that arise due to differences in prices for the same goods across different currencies.

The PPP Theory Says That in the Long Run the Exchange