Need to understand the difference between Absolute and Relative PPP. Also how important are these theories for international business?
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Absolute PP implies that "a bundle of goods should cost the same anywhere in the world once you take the exchange rate into account". Any deviations from this (if a basket of goods is cheaper in Canada than in the United States), then we should expect relative prices and the exchange rate between the two countries to move towards a level at which the basket of goods have the same price in the two countries.
Relative PPP describes differences in the rates of inflation between two countries. Specifically, suppose the rate of inflation in Canada is higher than that in the US, causing the price of a basket of goods in Canada to rise. Purchasing power parity requires the basket be the same price in each country, so this ...
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