Purchasing power parity implies:
A) a basket of goods should sell for the same price in all countries, even if trade barriers exist.
B) a basket of goods will sell for the same price in all countries as long as there are no trade barriers is a free flow of capital across borders.
C) a basket of goods cannot sell for the same price in different countries due to the different wage rates.
D) as long as all goods and services are traded freely across international boundaries, one unit of domestic currency should buy the same basket of goods anywhere in the world.

Question

Quizplus · Accepted Answer

Purchasing power parity (PPP) theory states that the exchange rate between two currencies is in equilibrium when their purchasing power is the same in each of the two countries. In other words, if PPP holds, one unit of the domestic currency should buy the same basket of goods anywhere in the world as long as all goods and services are traded freely across international boundaries. Choice A is incorrect because trade barriers can cause a price differential in the same basket of goods in different countries, violating PPP. Choice B is also incorrect because the free flow of capital does not ensure that prices are equal in different countries. Choice C is also incorrect because wage rates are not the only factor affecting prices, and PPP considers the overall price level of a basket of goods, not just wages.

Purchasing Power Parity Implies