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Purchasing Power Parity

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This solution is comprised of detailed explanation of purchasing power parity and how it relates to import and export. The referenced article is also attached in this solution.

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The Purchasing Power Parity Relative to Import/Export Rate.

Purchasing power parity (PPP) is after adjusting the exchange rates, similar goods would cost the same in different countries (Brigham & Houston, 2007). For example, a $2 chips in the United States may cost $8 pa'anga in Tonga. This means that PPP implies that the exchange rate is $2/$8 = $0.25 per pa'anga. PPP assumes that there are no transportation and transaction costs, or import restrictions, which is one shortage of the PPP since these assumptions do not occur in reality. Moreover, the $2 chips (could be Doritos or sun chips) in the U.S. may not be in Tonga as is always the case. However, PPP is useful when forecasting future situations.

The University of British Columbia (2008) stated, "Purchasing power parity (PPP) is a theory which states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries" (¶ 1). This means that the goods ...

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