The principle of ________ states that exchange rates are set so that the prices of similar products in different countries are about the same.
A) purchasing power parity
B) consumer price index
C) gross national product
D) nominal GDP

Question

Quizplus · Accepted Answer

The principle described in the question is called the purchasing power parity (PPP) theory. The theory suggests that in a world of perfect competition and without transaction costs, the exchange rate between two currencies should equal the ratio of the two countries' price levels for a basket of goods and services. This means that if the price of a product is lower in one country than another, then the exchange rate will adjust until the price in both countries is roughly the same. Therefore, the best answer is A) purchasing power parity.

The Principle of ________ States That Exchange Rates Are Set