The 'purchasing power parity theory' of exchange rate determination states that:
A)in the short run, costs of labour are the most important determinant of the exchange rate.
B)in the long run, a government agency sets the exchange rate between countries to maintain purchasing power.
C)in the long run, exchange rates will move to equalise the purchasing power of different countries.
D)in the long run, exchange rates are mainly driven by currency speculators' expectations.

Question

Quizplus · Accepted Answer

The purchasing power parity theory of exchange rate determination states that in the long run, exchange rates will move to equalize the purchasing power of different countries. This means that if the price of goods in the US is higher than in the UK, the exchange rate will adjust to make UK goods more expensive to US consumers and vice versa. This theory suggests that exchange rates are driven by fundamental economic factors, such as inflation and productivity, rather than by short-term speculative forces.

The 'Purchasing Power Parity Theory' of Exchange Rate Determination States