Question

The economic theory stating that the prices of identical goods in different countries should be equal after exchange rate adjustment is called:

• A. Law of Demand
• B. Purchasing Power Parity
• C. Opportunity Cost Theory
• D. Comparative Advantage Theory

Hint:

A famous informal way to measure PPP is the "Big Mac Index," which compares the price of a McDonald's Big Mac burger in different countries to see if currencies are "undervalued" or "overvalued."

Answer 1

The Correct Option is B

Step 1: Understanding the Concept:
This theory is based on the "Law of One Price." It suggests that in the absence of transaction costs and trade barriers, identical goods should cost the same when expressed in a common currency.

Step 2: Detailed Explanation:

• Purchasing Power Parity (PPP): Allows economists to compare the standard of living between countries by looking at how much a "basket of goods" costs in different places.
• Law of Demand: Relates price and quantity demanded.
• Opportunity Cost: The value of the next best alternative foregone.
• Comparative Advantage: Explains why countries should specialize in producing goods where they have a lower relative cost.

Step 3: Final Answer:
The theory is called Purchasing Power Parity.