Question

The purchasing power parity theory predicts better in the __________ run, and when there __________ in inflation rates across countries.

A) long; is little difference
B) short; are large differences
C) long; are large differences
D) short; is little difference

Answer 1

The purchasing power parity theory predicts better in the LONG run, and when there ARE LARGE DIFFERENCES in inflation rates across countries.

Step-by-step explanation:

The purchasing power parity theory is used to compare different economies while considering the relative value of their currencies. The whole purpose of this theory is to try to account for difference in domestic prices. The US dollar is used as the basis, and depending on the relative exchange rates, the general price level is adjusted.

The logic behind this theory is that local prices vary and GDP per capita should be adjusted by how much can be bought with an X amount of local money vs how much it would cost to purchase similar goods in another country. E.g. a standard house in Switzerland costs approximately $500,000, but with that much money you could easily purchase 10 similar houses in poorer nations. So a person earning $30,000 in Switzerland might be considered poor while a similar salary is considered a very high salary in another countries.

Answer 2

C) long; are large differences

Explanation:

The parity theory in effects asserts that the difference today (short run) in the purchase power between two countries will likely become closer tomorrow (long run) if one of the countries inflation rate increases significantly.

Thus, over time the relative purchasing power parity becomes better.