When the ratio of domestic prices to foreign prices falls,________.

Question

Quizplus · Accepted Answer

The ratio of domestic prices to foreign prices is known as the relative price level, and when it falls, it means the domestic prices are decreasing relative to foreign prices. This, in turn, leads to a depreciation of the real exchange rate, which reflects the relative purchasing power of domestic and foreign currencies. The real exchange rate can depreciate even if the nominal exchange rate is constant, as long as the decrease in relative price levels is sufficient to offset any nominal exchange rate stability. Therefore, option C is the correct answer.

When the Ratio of Domestic Prices to Foreign Prices Falls,________