According to the purchasing power parity theory increase in domestic price level will bring about … . Select one – the most appropriate answer to fill in the space above.

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The question asks about the implication of a rise in the domestic price level under purchasing power parity (PPP) theory.
Option 1: 'Depreciation of foreign currency.' PPP focuses on the domestic price level relative to foreign prices and exchange rate movements, so a rise in domestic prices typically affects the domestic currency, not primarily the foreign one. This option misstates the usual direction of the currency adjustment under PPP.
Option 2: 'All answers are correct.' Given that other options describe different and inconsistent outcomes, this broad claim cannot be true unless every listed outcome is valid, which is not the case here. Therefore this option is incoherent.
Option 3: 'Depreciation of domestic currency.' This aligns with PPP intuition: if domestic prices rise relative to foreign prices, the domestic currency tends to depreciate to restore equal purchasing power across countries. This makes domestic currency depreciation the correct implication in the PPP framework.
Option 4: 'Appreciation of domestic currency and drop in foreign economy price level.' This contradicts PPP: higher domestic price levels typically exert downward pressure on the domestic currency, not appreciation, and it mentions a drop in foreign prices which would not be the PPP consequence of a domestic price increase.
Option 5: 'No correct answer.' Since option 3 accurately reflects PPP reasoning, this statement is false.
Option 6: 'Appreciation of foreign currency and respective jump in foreign economy price level.' This would imply foreign currency strengthening, which is inconsistent with a domestic price increase under PPP, where the domestic currency tends to weaken relative to foreign currency.
Overall, the reasoning points toward domestic currency depreciation as the plausible PPP consequence, while the other options either misstate the direction of currency movement or claim universal/contradictory outcomes. The result hinges on the relative price levels and exchange rate adjustments predicted by PPP, which require the domestic price level to rise relative to foreign prices, prompting depreciation of the domestic currency.

econ_420_120255_249094 Lesson 13 Quiz

According to the purchasing power parity theory increase in domestic price level will bring about … . Select one – the most appropriate answer to fill in the space above.

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