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Theory of Purchasing Power Parity

Question:

The Theory of Purchasing Power Parity says that, in the long run, nominal exchange rates change to offset changes in relative i. _________________________ so that the purchasing power of two currencies stays roughly at parity.
ii. Briefly Explain?

Answer:

The idea behind PPP theory is that in the long run a good should cost the same price in all the countries, irrespective of the currency. Therefore, the exchange rates change in accordance with the price of a good in a particular economy, so that the actual prices in both the countries are same.

 

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