Share
Explore BrainMass

Purchasing Power Parity (PPP)

1. Explain the theory of purchasing power parity (PPP). Based on this theory, what is a
general forecast of the values of currencies in countries with high inflation?

2. Explain the rationale of the PPP theory.

3. Explain how you could determine whether PPP exists. Describe a limitation in testing
whether PPP holds.

4. Inflation differentials between the U.S. and other industrialized countries have typically
been a few percentage points in any given year. Yet, in many years annual exchange
rates between the corresponding currencies have changed by 10 percent or more. What
does this information suggest about PPP?

5. Explain why PPP does not hold.

Solution Preview

1. Explain the theory of purchasing power parity (PPP). Based on this theory, what is a
general forecast of the values of currencies in countries with high inflation?

ANSWER: PPP suggests that the purchasing power of a consumer will be similar when purchasing goods in a foreign country or in the home country. If inflation in a foreign country differs from inflation in the home country, the exchange rate will adjust to maintain equal purchasing power.

Currencies in countries with high inflation will be weak according to PPP, causing the purchasing power of goods in the home country versus these countries to be similar.

2. Explain the rationale of the PPP theory.

ANSWER: When inflation is high in a particular country, foreign demand for goods in that country ...

Solution Summary

This posting answers five questions related to Purchasing Power Parity (PPP).

$2.19