The economic theory stating that the prices of identical goods in different countries should be equal after exchange rate adjustment is called:
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A famous informal way to measure PPP is the "Big Mac Index," which compares the price of a McDonald's Big Mac burger in different countries to see if currencies are "undervalued" or "overvalued."
Step 1: Understanding the Concept:
The "Law of One Price" states that in the absence of transaction costs and trade barriers, identical goods should sell for the same price in different markets. Step 2: Detailed Explanation:
Purchasing Power Parity (PPP) is an extension of the law of one price to the international level.
It suggests that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries.
This means that a bundle of goods should cost the same in USD as it does in INR once the exchange rate is applied.
\[ \text{Exchange Rate} = \frac{P_1}{P_2} \]
Where \(P_1\) is the price of a basket of goods in country 1 and \(P_2\) is the price of the same basket in country 2.
Option (A) relates price to quantity demanded.
Option (C) and (D) are theories explaining why countries trade based on production efficiencies. Step 3: Final Answer:
The theory described is Purchasing Power Parity.