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The purchasing power parity theory of exchange rate determination maintains that:
a. The exchange rate between two currencies is determined by the debt that each nation owes to the World Bank.
b. The exchange rate between two nations’ currencies is determined by the percent of gold that backs each nation’s currency.
c. The exchange rate between two nations’ currencies adjusts to reflect differences in the price levels in the two nations.
d. In the short run, exchange rates are determined by central bank intervention in the currency markets.

Sagot :

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Explanation:

The correct answer is (c) The exchange rate between two nations' currencies adjusts to reflect differences in the price levels in the two nations.

The Purchasing Power Parity (PPP) theory suggests that exchange rates adjust to equalize the purchasing power of different currencies, based on the prices of a basket of goods and services in each country. This means that if prices are higher in one country than in another, the exchange rate will adjust to reflect this difference, making the currency of the country with higher prices weaker relative to the other currency.

The other options are not accurate representations of the PPP theory:

(a) Debt to the World Bank is not a factor in PPP.

(b) The gold standard is no longer used to back currencies, and PPP is not related to gold reserves.

(d) Central bank intervention can influence exchange rates in the short term, but PPP is a long-term equilibrium theory.

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