Question

Describe the relation between inflation differences between countries and depreciation of foreign exchange rate against the reference country currency by referring to Purchasing Power Parity.Explain briefly)

Answer 1

Ans 3. There is a close relationship between inflation differences between countries and depreciation of foreign exchange rate against the reference country currency by referring to purchasing power parity.
Inflation is a situation there the value of currency will decrease and the price of good will increase and under inflation it is also a situation where money circulation is high in the country.
It is beneficial for the other country to purchase the goods from that country where inflation is high because as per the purchasing power parity theory the value of currency will increases or decreases the purchasing power of the consumers if the value of currency is high then the purchasing power of the consumer is also high and if the value of currency is low then the purchasing power of the consumer is also low.
If there is a depreciation of foreign exchange rate then it means it is easy to purchase the goods from that country because weak currency increases the purchasing power of other country because now the strong currency based country will able to purchase more of the commodity at a same price from the week currency based country.