If the GDP deflator in the United States is 114,and the GDP deflator in Ukraine is 142,which of the following exchange rates would the theory of purchasing power parity predict in the long run? (The Ukrainian currency is the hryvnia.)

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Quizplus · Accepted Answer

The theory of purchasing power parity (PPP) suggests that in the long run, exchange rates should adjust so that an identical basket of goods in two different countries will cost the same amount when priced in the same currency. To find the predicted exchange rate, you can use the ratio of the GDP deflators. The calculation is 142 (Ukraine's GDP deflator) / 114 (US GDP deflator) = 1.25. This means, according to PPP, 1 US dollar should exchange for 1.25 hryvnias in the long run.

If the GDP Deflator in the United States Is 114,and