Which of the following statements about the purchasing power parity (PPP) theory are correct?
(A) It is used to make long-run predictions about exchange rates in a flexible exchange rate system.
(B) It assumes that there are no barriers to trade like tariffs and quotas.
(C) It says the same product costs the same in two countries even after adding the cost of transporting it.
(D) Over the long run, exchange rates adjust to reflect differences in the price levels of the two countries.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → (A), (B) and (D) only
Purchasing power parity says that, with free trade, a product should cost the same in two countries once prices are put in one currency.
(A) It is used to make long-run predictions about exchange rates in a flexible exchange rate system. — Correct. PPP is a long-run theory for flexible rates.
(B) It assumes that there are no barriers to trade like tariffs and quotas. — Correct. Tariffs and quotas would stop prices from evening out.
(C) It says the same product costs the same in two countries even after adding the cost of transporting it. — Incorrect. The theory allows for differences in transportation; prices are equal except for transport costs.
(D) Over the long run, exchange rates adjust to reflect differences in the price levels of the two countries. — Correct. This is the main result of PPP.
NCERT (2026-27): “Exchange Rates in the Long Run The purchasing Power (PPP) theory is used to make long-run predictions about exchange rates in a flexible exchange rate system. According to the theory, as long as there are no barriers to trade like tariffs (taxes on trade) and quotas (quantitative limits on imports), exchange rates should eventually adjust so that the same product costs the same whether measured in rupees in India, or dollars in the US, yen in Japan and so on, except for differences in transportation. Over the long run, therefore, exchange rates between any two national currencies adjust to reflect differences in the price levels in the two countries.” |