Question

Your book describes the increase in the money supply as being analogous to giving people more money. If the output of goods and services is not growing at a similar rate, inflation will eventually occur. According to PPP Theory, what will happen to the U.S. dollar

Answer 1

Answer: The U.S dollar needs to be depreciated.

Explanation:

Purchasing power parity (PPP) is a theory that states that the exchange rates between currencies will be in equilibrium when their purchasing power is equal in both countries. This implies that the exchange rate between the two countries should be equal to the ratio of the two nations price level of a fixed basket of commodities. When there is an increase in a country's domestic price level i.e. a nation is experiencing inflation, the country's exchange rate should be depreciated in order for it to return to PPP. The aim of PPP is the "law of one price". Without transportation and other costs involved in transaction, the price of identical goods in competitive markets will be equal when the price is expressed in same currency. In this case, if there's inflation in the United States, the country's currency need to be depreciated for it to return to PPP.