Multiple choice

Many times we read in newspapers that the Rupee is appreciating. When we consider the rupee-dollar exchange rate in the light of Purchasing Power Parity (PPP) we think that the exchange rate of the two currencies should

  1. be equal to the ratio of price levels in the two countries

  2. not be equal to the ratio of price levels in the two countries

  3. be decided on the basis of the value of the third major currency i.e. Euro or Yen

  4. necessarily be different for both the currencies as the economies of both of them are driven on two different sets of variables and it has no relation with PPP

  5. None of these
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A Correct answer
Explanation

Purchasing Power Parity (PPP) theory suggests that in the absence of trade barriers, the exchange rate between two currencies should reflect the ratio of their respective price levels. This ensures that a unit of currency has the same purchasing power in both countries.

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