Purchasing power parity holds best when prices are free to adjust and there are no trade barriers.

Question

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Purchasing power parity suggests that the exchange rate between two countries should equate to the ratio of the price levels in the two countries. This theory holds best when prices are free to adjust and there are no trade barriers, as these factors can impact the flow of goods and services between countries and distort price levels. Without these hindrances, the theory of purchasing power parity can more accurately reflect the true exchange rate.

Purchasing Power Parity Holds Best When Prices Are Free to Adjust