According to the purchasing power parity theory,in the long run:

A) the exchange rate between any two currencies should be equal all over the world.
B) the value of the U.S.dollar should equal the value of the pound which should equal the value of the yen.
C) inflation rates should equalize around the world.
D) interest rates should equalize around the world.
E) the exchange rate between the currencies of two countries should reflect the differences in price levels in the two countries.

Question

Aaron Corral · Accepted Answer

Final Answer : E, Explanation :  According to the purchasing power parity theory, the exchange rate between the currencies of two countries should reflect the differences in price levels in the two countries in the long run. This means that if one country has a higher inflation rate and prices are increasing faster than another country, the value of its currency should depreciate to reflect the difference in purchasing power. Similarly, if one country has lower inflation and prices are relatively stable, its currency should appreciate in value. Thus, the exchange rates should adjust to maintain parity in purchasing power between the two countries. However, the theory may not hold in the short run due to factors such as speculation, interest rate differentials, and government interventions in currency markets.

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