If purchasing power parity holds, then which of the following statements must be true?

Question

Quizplus · Accepted Answer

According to purchasing power parity, the exchange rate between two currencies should be such that the purchasing power of both currencies is equal. Therefore, if a country has a lower average inflation rate, its currency should appreciate relative to the currencies of other countries. This is because its goods and services will be relatively cheaper, and buyers will demand more of them, which will lead to an increase in demand for the country's currency. Purchasing power parity (PPP) suggests that the exchange rate between two countries should equal the ratio of the price levels of the two countries. Therefore, if a country has a lower rate of inflation, its currency should appreciate relative to other countries because its goods and services will become relatively cheaper. Conversely, if a country has a higher rate of inflation, its currency should depreciate relative to other countries. Therefore, choice A is the correct answer.

If Purchasing Power Parity Holds, Then Which of the Following