Q. Consider the following statements regarding the Rupee-Dollar exchange rate in light of the Purchasing Power Parity (PPP) theory:- Purchasing Power Parity suggests that the exchange rate between two currencies should be equal to the ratio of price levels in the two countries.
- PPP theory states that the exchange rate between two currencies should not be related to the ratio of their price levels.
- The PPP theory mandates that the exchange rate should be determined by the value of a third major currency such as the Euro.
Which of the above statements is/are correct?
Answer:
Only 1
Notes: Purchasing Power Parity (PPP) holds that the exchange rate of two currencies should equal the ratio of their respective price levels. Statement 1 correctly reflects this principle. Statements 2 and 3 are incorrect as PPP does not disregard the price-level ratio nor does it base the exchange rate on a third major currency like the Euro.