Assertion (A): If prices in India rise by 10 per cent while prices in the US rise by 30 per cent, the purchasing power parity theory predicts that the rupee will appreciate against the dollar.
Reason (R): Over the long run, exchange rates between two currencies adjust to reflect differences in the price levels of the two countries.
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Both (A) and (R) are true and (R) is the correct explanation of (A).
Assertion (A): If prices in India rise by 10 per cent while prices in the US rise by 30 per cent, the purchasing power parity theory predicts that the rupee will appreciate against the dollar. — True. US prices rise faster, so a dollar buys less. Fewer rupees should equal a dollar, so the rupee appreciates.
Reason (R): Over the long run, exchange rates between two currencies adjust to reflect differences in the price levels of the two countries. — True. This is the PPP result.
Why R explains A?
A is about the direction in which the rupee moves. R gives the rule behind it: the rate follows the price-level gap. Since US prices rise more, the rate moves in favour of the rupee. For example, if Indian prices rise 20 per cent and US prices 50 per cent, the rate falls from Rs 50 to Rs 40 per dollar.
NCERT (2026-27): “Exchange Rates in the Long Run … 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 … Next, we suppose that prices in India rise by 20 per cent while prices in the US rise by 50 per cent. Indian shirts would now cost Rs 480 per shirt while American shirts cost $12 per shirt. For these two prices to be equivalent, $12 must be worth Rs 480, or one dollar must be worth Rs 40. The dollar, therefore, has depreciated.” |