Prices of European goods are rising faster than prices of similar goods in the United States.Consequently Europeans substitute American goods for European goods and the euro depreciates.This phenomenon is the basis of

Question

Quizplus · Accepted Answer

This phenomenon is an example of purchasing power parity (PPP), which states that exchange rates should adjust to equalize the price of identical goods and services in different countries. In this case, the rising prices in Europe cause the euro to depreciate, as the PPP theory predicts, allowing for American goods to appear relatively cheaper and be substituted for European goods. Ricardo's Law, comparative advantage, and absolute advantage do not fully explain this phenomenon.

Prices of European Goods Are Rising Faster Than Prices of Similar