Economics • Economic BasicsMedium
In the context of international trade theory, what does 'Purchasing Power Parity (PPP)' assert?
A. Nominal exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries✓ Correct Answer
B. Tariffs and non-tariff barriers should be eliminated to ensure equal export volumes between trading partners
C. Central banks must maintain fixed exchange rates to prevent speculative capital outflows
D. The domestic interest rate of a country must equal the world interest rate plus expected depreciation
💡 Solution & Explanation
Purchasing Power Parity is an economic theory that estimates the adjustment needed between the exchange rates of two countries for an exchange rate to be equivalent to each country's purchasing power. It is based on the law of one price, stating that in the absence of transportation costs and trade barriers, identical goods must have the same price when expressed in a common currency. Trade barriers and transportation costs often cause deviations from absolute PPP in the short run.
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