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NEW QUESTION: 1
Which of the following is not correct about the purchasing power parity theory of explaining changes in
exchange rates?
A. Interest rates include a premium or discount that ensures purchasing power parity.
B. The purchasing power parity theory is presented in both absolute and relative form.
C. Inflationary forces on foreign and domestic currencies will cause the exchange rates to automatically
adjust to ensure that a common currency will have identical or similar purchasing power in each economy
for similar goods.
D. Purchasing power of a common currency in different economies for similar products will remain the
same.
Answer: A
Explanation:
Choice "c" is correct. The purchasing power parity theory holds that inflation will cause exchange rates to
automatically adjust to ensure that an equal amount of a common currency will purchase similar goods in
separate economies. The International Fischer effect considers the premium or discount on interest rates
as an indicator of inflation. Choice "a" is incorrect. The basic idea underlying the purchasing power parity
theory is that the purchasing power of a common currency in different economies for similar products will
remain the same and that inflation in any particular economy will cause exchange rates to adjust until
parity is consistently achieved. Choice "b" is incorrect. The purchasing power parity theory holds that
inflationary forces on foreign and domestic currencies will cause the exchange rates to automatically
adjust to ensure that a common currency will have identical or similar purchasing power in each economy
for similar goods. Choice "d" is incorrect. The purchasing power parity theory is presented as both an
absolute theory of parity determination regardless of market imperfections and as a relative concept that
considers market imperfections.
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