Which of the following is a feature of the 'Purchasing Power Parity' theory in its absolute form?
A. Only relative changes in prices matter
B. The exchange rate equals the interest differential
C. The exchange rate between two currencies equals the ratio of the countries’ price levels
D. Exchange rates are determined only by trade balances
Answer: Option C
Solution (By JKSSB Mock Tests)
Absolute purchasing power parity states that the nominal exchange rate should equal the ratio of the domestic to the foreign price level so that a basket of goods costs the same in both countries.
Explanation:
According to Milton Friedman's permanent income hypothesis, individuals base their consumption on permanent (expected long-run) income rather than on current measured income.
Explanation:
In the long run, free entry eliminates supernormal profits under monopolistic competition. Firms operate on the falling portion of their LAC curve, implying excess capacity.
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