Question

Cross country comparisons of GDP per capita typically use purchasing power parity equivalent exchange rates. Why could using market exchange rates be misleading?

a) Market exchange rates are influenced by short-term fluctuations
b) Market rates are more accurate in the long run
c) Market rates consider inflation rates
d) Market rates are less affected by international trade

Answer 1

Market exchange rates are influenced by short-term fluctuations, making them less reliable for cross-country comparisons. PPP equivalent exchange rates provide a longer-run measure of the exchange rate and are considered more accurate for comparing GDP per capita between countries. So, the correct answer is option a.

Step-by-step explanation:

When comparing GDP per capita between countries, economists generally use purchasing power parity (PPP) equivalent exchange rates rather than market exchange rates. This is because market exchange rates are influenced by short-term fluctuations, making them less reliable and more volatile for cross-country comparisons. On the other hand, PPP equivalent exchange rates provide a longer-run measure of the exchange rate and are considered to be a better indicator of the real purchasing power of currencies.

So, the correct answer is option a.