Question

According to the absolute purchasing power parity (PPP) hypothesis,

	a.	the real exchange rate, ϵ = eP/P*, between the currencies of two trading countries must always be equal to one.
	b.	the real exchange rate, ϵ = eP/P*, between the currencies of two trading countries must be constant, but not necessarily equal to one.
	c.	the ratio of the real GDPs of two trading countries must be equal to one when measured with a common set of prices.
	d.	the ratio of the real GDPs of two trading countries must constant over time, but not necessarily equal to one, when measured with a common set of prices.
	e.	none of the above.

Answer 1

Option d) the ratio of real GDPs of two countries must be constant over time but not equal to one, when measured with a common set of price

Reason: PPP exchange rates help costing but exclude profits and above all do not consider the different quality of goods among countries. The same product, for instance, can have a different level of quality and even safety in different countries, and may be subject to different taxes and transport costs.