If inflation in country A exceeds inflation in country B, purchasing power parity implies that:
A) the currency of country B should depreciate relative to the currency of country A.
B) the inflation rate in country B will rise to match the inflation rate in country A.
C) the currency of country A will depreciate relative to the currency of country B.
D) the inflation rate in country A will fall to match the inflation rate in country B.

Question

Quizplus · Accepted Answer

According to purchasing power parity theory, if inflation in one country exceeds the inflation rate in another country, the currency of the country with higher inflation will depreciate relative to the currency of the country with lower inflation. This happens because the goods in the country with higher inflation are becoming relatively more expensive compared to goods in the country with lower inflation, leading to a reduction in demand for the former country's currency. Therefore, the correct answer is C, which states that the currency of country A will depreciate relative to the currency of country B.

If Inflation in Country a Exceeds Inflation in Country B