According to the theory of 'purchasing power parity', the foreign exchange market will:
A)no longer demand Australian dollars if the inflation rate in Australia is higher than the inflation rates in other countries.
B)undervalue the Australian dollar if inflation in Australia is higher than the inflation rates in other countries.
C)adjust the value of currencies to reflect differing inflation rates between countries.
D)result in an increase in the supply of dollars whenever Australia's inflation rate is lower than the inflation rates in other countries.

Question

Quizplus · Accepted Answer

According to the theory of purchasing power parity, the exchange rate between two currencies should adjust to reflect the difference in inflation rates between the two countries. If the inflation rate in a country is higher than the inflation rates in other countries, its currency will depreciate to reflect the decrease in purchasing power. Similarly, if a country's inflation rate is lower than other countries, its currency will appreciate. Therefore, the foreign exchange market will adjust the value of currencies to reflect differing inflation rates between countries. Hence, option C is the correct choice.

According to the Theory of 'Purchasing Power Parity', the Foreign