Question

The existence of purchasing power parity in an open economy implies that
(A) The purchasing power of individuals depends on inflation rate
(B) The exchange rate between two countries' currency is equal to the ratio of their price levels
(C) Law of one price holds
(D) The price levels of all countries are equal when measured in terms of the same currency
Choose the correct answer from the options given below:

• A. (A), (B) and (D) only
• B. (A), (B) and (C) only
• C. (A), (B), (C) and (D)
• D. (B), (C) and (D) only

Hint:

PPP implies that exchange rates are determined by price level differences between countries.

Answer 1

The Correct Option is D

Purchasing Power Parity (PPP) theory posits the following in an open economy:

(B) The exchange rate between two nations is dictated by their relative price levels.

(C) The law of one price is valid; identical products will have the same price when measured in the same currency.

(D) Price levels across all countries should be equivalent when valued in a common currency.

Consequently, the premise in (D) is a fundamental conclusion.