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Exchange rate determination is a critical aspect of international finance and is influenced by various economic theories. The primary theories explaining how exchange rates are determined include: 1. Purchasing Power Parity (PPP) Theory: According to the PPP theory, exchange rates are determined by the relative prices of goods between two countries. It suggests that in the long run, the exchange rate between two currencies should equal the ratio of the countries’ price levels. If a country experiences inflation, its currency should depreciate in proportion to maintain parity in purchasing power. There are two forms of PPP – absolute and relative. Absolute PPP assumes that identical goods should have the same price globally when expressed _______ ______ _________ ________ _____ ______ _______.
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