Understanding Purchasing Power Parity in Exchange Rates

Easy Currency Exchange Rates Exchange Rate Models

In the context of currency exchange rates, one important theoretical model is the Purchasing Power Parity (PPP). PPP proposes a relationship between the prices of goods and services in different countries, suggesting that in the long run, currency exchange rates should adjust to equalize the price of an identical basket of goods and services across different economies.

Consider the following statements about the PPP model:

Which of the following statements accurately describes a principle of the Purchasing Power Parity model?

The PPP model assumes that exchange rates move only in response to changes in interest rates.

The PPP model indicates that currencies should adjust to reflect differences in national price levels.

The PPP model suggests that foreign exchange markets operate without any form of transaction costs.

Hint

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