The country’s relative price level is rising. This would cause its currency to:

Question

BlackTom AI · Accepted Answer

Purchasing-power parity (PPP) links relative price levels to the nominal exchange rate, so when domestic prices rise relative to foreign prices the home currency must lose value in the long run.

1) Relevant concepts
- Nominal exchange rate S: units of domestic currency per unit of foreign currency (an increase in S = domestic currency depreciation).
- Relative price level: P (domestic) versus P* (foreign).
- Purchasing-power parity (long-run relationship): S = P / P*.
- Percent-change form: ΔS/S ≈ ΔP/P − ΔP*/P*.

2) Step-by-step reasoning
If the domestic price level P increases faster than the foreign price level P*, then the ratio P/P* rises. Under PPP the nominal exchange rate S must rise by the same proportion so that S = P/P* continues to hold. An increase in S means more domestic currency is needed to buy one unit of foreign currency — i.e., the domestic currency depreciates.

3) Intermediate calculation
Starting from S = P / P*:
Take proportional (percentage) changes: ΔS/S = ΔP/P − ΔP*/P*.
If ΔP/P > ΔP*/P* (domestic inflation higher than foreign), then ΔS/S > 0 → S increases → depreciation of domestic currency.

4) Why this answer is correct
In the long run goods and prices adjust, so PPP is a good guide: a higher domestic price level reduces the purchasing power of the domestic currency and the nominal exchange rate must move (depreciate) to restore parity.

5) Why the other choices are incorrect
- "Depreciate in short run": short-run movements are ambiguous because prices are sticky and financial flows can temporarily offset the inflation effect; depreciation is not guaranteed immediately.
- "Appreciate in long run": contradicts PPP — rising domestic prices relative to abroad imply loss of value, not gain.
- "Appreciate in short run": also unlikely as a general prediction of a relative domestic price-level rise; any short-run appreciation would be due to special capital flows, not the price effect itself.

6) Conclusion
Therefore, the correct outcome is that the currency will depreciate in the long run, matching the provided answer: depreciate in long run.

The country’s relative price level is rising. This would cause its currency to:Single choice

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