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Relationship between Inflation and Purchasing Power Parity

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A. Explain the concept of 'purchasing power parity' (PPP) in your own words.
B. What are the requisite conditions for PPP to exist?
C. What is the relationship between PPP and exchange rates?

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Solution Summary

This posting gives you a step-by-step explanation of Purchasing Power Parity . The response also contains the sources used.

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Step 1.
Purchasing Power Parity means that the foreign exchange rate alters itself so that the same good in two countries has the same price when expressed in the same currency. This means that the amount of adjustment of exchange rate required will ensure that the exchange rate reflects the purchasing power of each currency. The PPP concept means that the exchange rate between two currencies is stable when their local purchasing powers at the rate of exchange are similar. The concept uses a bundle of goods. The bundle should ...

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