What does the concept of purchasing power parity suggest?

The concept of purchasing power parity (PPP) suggests that movements in exchange rates should offset inflation differentials between two countries. According to PPP, if one country has a higher inflation rate than another, its currency should depreciate relative to the other country's currency to maintain the purchasing power of each currency. This means that the price levels of identical goods should be the same when expressed in a common currency.

The essence of PPP is that the nominal exchange rate between two currencies reflects the relative price levels in the two countries. Therefore, if inflation rises in one country compared to another, it can be expected that the exchange rate will adjust accordingly to maintain parity in purchasing power. Hence, the correct answer aligns with this fundamental principle, accurately reflecting the relationship between inflation differentials and exchange rate movements prescribed by purchasing power parity.