The law of one price and purchasing power parity (PPP)theory predict that the exchange rate will change if relative prices change.

Question

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The law of one price and PPP theory suggest that if there is a change in relative prices, then the exchange rate will also change. The law of one price asserts that identical goods should have the same price in all markets, while PPP theory proposes that in the long run, exchange rates should adjust so that the same basket of goods and services has the same cost in different countries. As a result, if there is a change in the price of goods and services in one country relative to another, the exchange rate will need to adjust to maintain these principles.

The Law of One Price and Purchasing Power Parity (PPP)theory