Correct question:
The theory of purchasing-power parity says that higher inflation in a nation causes the nation's currency to ________, leaving the ________ exchange rate unchanged.
appreciate, nominal
appreciate, real
depreciate, nominal
depreciate, real
Answer:
Depreciate, real.
Explanation:
The theory of purchasing power parity says that the nominal exchange rate equals the ratio of the foreign price level (measured in units of the foreign currency) to the domestic price level (measured in units of the domestic currency): e=P*/P . As the domestic price level increases (due to higher inflation), e decreases. This depreciation of the currency, however, does not affect the real exchange rate
