If the GDP deflator in Canada is 114, and the GDP deflator in Ukraine is 142, which of the following exchange rates would the theory of purchasing power parity predict in the long run? (The Ukrainian currency is the hryvnia.)

Question

Quizplus · Accepted Answer

According to the theory of purchasing power parity (PPP), the exchange rate between two countries should be proportionate to the ratio of their price levels or GDP deflators. 
Therefore, the exchange rate between the Canadian dollar and the Ukrainian hryvnia can be calculated as follows:

Exchange rate = Canadian GDP deflator / Ukrainian GDP deflator

Exchange rate = 114/142 = 0.802 
Therefore, the PPP predicts that one Canadian dollar should buy 0.802 Ukrainian hryvnias in the long run. 
Choice C, which is 1.25 hryvnias per dollar, is the closest to this predicted exchange rate.

If the GDP Deflator in Canada Is 114, and the GDP