Question

According to purchasing-power parity, if prices in Canada increase by a smaller percentage than prices in Algeria, how does the exchange rate change? Select one: a. The nominal exchange rate, defined as Algerian currency per dollar, rises. b. The nominal exchange rate, defined as Algerian currency per dollar, falls. c. The real exchange rate, defined as Algerian goods per unit of Canadian goods, rises. O d. The real exchange rate, defined as Algerian goods per unit of Canadian goods, falls. In the aggregate demand and aggregate supply model, when does the aggregate quantity of goods

Answer 1

In accordance with purchasing-power parity, if prices in Canada increase less than in Algeria, the Canadian dollar appreciates and the nominal exchange rate, as Algerian currency per Canadian dollar, falls.

Step-by-step explanation:

According to purchasing-power parity (PPP), if prices in Canada increase by a smaller percentage than prices in Algeria, then the value of the Canadian currency is expected to appreciate relative to the Algerian currency. An appreciation of the Canadian dollar means that the nominal exchange rate, defined as Algerian currency per Canadian dollar, would fall. Conversely, a depreciation of the Algerian currency relative to the Canadian dollar suggests that it would take more Algerian currency to buy one Canadian dollar.

Using the mirror image principle of exchange rates, if the value of the Canadian dollar in terms of Algerian currency goes up, the nominal exchange rate, which can also be expressed as how many units of Algerian currency can be obtained for one Canadian dollar, would decrease. This is because each Canadian dollar is now able to buy more Algerian currency due to its stronger purchasing power. Therefore, option b is the correct answer: The nominal exchange rate, defined as Algerian currency per dollar, falls.