A shirt costs $8 in the US and Rs 600 in India. According to the purchasing power parity theory, what should the rupee-dollar exchange rate be? If the actual rate is Rs 80 per dollar, where would foreign customers buy shirts?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Rs 75; from India
Under purchasing power parity, the exchange rate should make the same product cost the same in both countries, apart from transport costs.
Given:
Price in the US = $8
Price in India = Rs 600
Actual rate = Rs 80 per dollar
\( \displaystyle \text{PPP rate} = \frac{600}{8} = \text{Rs } 75 \text{ per dollar} \)
\( \displaystyle \text{US shirt at Rs 80} = 8 \times 80 = \text{Rs } 640 \)
The PPP rate is Rs 75. At Rs 80, the US shirt costs Rs 640 against Rs 600 in India, so foreign customers would buy from India.
Option (2) Rs 75; from the US — Incorrect. At a rate above Rs 75, the shirt is cheaper in India, not in the US.
Option (3) Rs 80; from neither, since the price is the same in both — Incorrect. Rs 80 is the actual rate, not the PPP rate; at Rs 80 the two prices differ.
Option (4) Rs 85; from India — Incorrect. Rs 600 ÷ 8 is 75, not 85.
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.” “EXAMPLE If a shirt costs $8 in the US and Rs 400 in India, the rupee-dollar exchange rate should be Rs 50. To see why, at any rate higher than Rs 50, say Rs 60, it costs Rs 480 per shirt in the US but only Rs 400 in India. In that case, all foreign customers would buy shirts from India. …” |