According to purchasing power parity, the foreign exchange market will
A) undervalue the dollar if inflation in the United States is greater than it is elsewhere.
B) no longer demand dollars if the inflation rate in the United States exceeds that of other nations.
C) adjust the value of the exchange rate to reflect differing inflation rates between nations.
D) result in a flow of dollars out of the United States whenever its rate of inflation is below that of other nations.

Question

Quizplus · Accepted Answer

Purchasing power parity (PPP) theory states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries. This means that the exchange rate between two countries will adjust to reflect differences in inflation rates, making option C correct.

According to Purchasing Power Parity, the Foreign Exchange Market Will