The theory of purchasing power parity implies the real exchange rate between two countries is:
A) flexible.
B) less than one.
C) greater than one.
D) equal to one.

Question

Quizplus · Accepted Answer

According to the theory of purchasing power parity (PPP), the real exchange rate between two countries should be equal to one in the long run. This means that the currencies of two countries will adjust to maintain the same purchasing power. If the real exchange rate deviates from one, there will be an incentive for arbitrage, leading to the adjustment of exchange rates until PPP is restored. Therefore, the answer is D: equal to one.

The Theory of Purchasing Power Parity Implies the Real Exchange