According to the theory of purchasing power parity, if the price level in France rises by 6 percent and the price level in the United States rises by 4 percent, then the dollar will
A) appreciate by 2 percent against the euro in the short run.
B) depreciate by 2 percent against the euro in the short run.
C) appreciate by 2 percent against the euro in the long run.
D) depreciate by 2 percent against the euro in the long run.

Question

Quizplus · Accepted Answer

Purchasing power parity (PPP) theory suggests that exchange rates will adjust to compensate for changes in price levels between two countries, ensuring that goods cost the same in both countries when priced in a common currency. If the price level in France rises by 6 percent and in the United States by 4 percent, the euro should depreciate and the dollar should appreciate to restore parity. The correct answer is that the dollar will appreciate by 2 percent against the euro in the long run, as PPP adjustments typically occur over the long run rather than immediately.

According to the Theory of Purchasing Power Parity, If the Price