Which of the following statements is the most accurate?
A) If PPP holds true, then the law of one price holds true for every commodity as long as the reference baskets used to reckon different countries' price levels are the same.
B) If the law of one price holds true for every commodity, PPP must hold automatically.
C) If the law of one price holds true for every commodity, PPP must automatically hold as long as the reference baskets used to reckon different countries' price levels are the same.
D) If the law of one price does not hold true for every commodity, PPP cannot be true as long as the reference baskets used to reckon different countries' price levels are the same.
E) If PPP holds true, then the law of one price must hold true automatically.

Question

Quizplus · Accepted Answer

The statement in option C is the most accurate because it acknowledges the necessary condition that the reference baskets used to calculate different countries' price levels need to be the same for PPP to hold true. The law of one price states that the same good should sell for the same price in different markets, whereas PPP is an equilibrium condition that relates exchange rates to price levels across countries. If the law of one price holds true for every commodity, it means that there are no arbitrage opportunities left for traders to profit from price differentials. However, if the reference baskets used to calculate price levels are different between countries, then the exchange rate derived from the law of one price may not be the same as the one required for PPP to hold true. Therefore, option C is the most accurate because it specifies the condition that must hold for PPP to be supported by the law of one price.

Which of the Following Statements Is the Most Accurate