If a basket of goods costs $100 in the United States and €120 in Europe, what would the purchasing power parity theory's prediction of the dollar/euro exchange rate be?

Question

Quizplus · Accepted Answer

The purchasing power parity theory states that the exchange rate between two currencies should be equal to the ratio of the prices of a basket of goods in the two countries. In this case, the basket of goods costs $100 in the United States and €120 in Europe, so the exchange rate should be $1 = €1.20.

If a Basket of Goods Costs $100 in the United