Explain purchasing power parity, International Economics

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Q. Explain Purchasing Power Parity.

Answer: PPP () states that the exchange rate between two countries' currencies equals the ratio of the countries' price levels.

A decrease in a currency's domestic purchasing power that is an increase in the domestic price level will be associated with proportional currency depreciation in the foreign exchange market and vice versa.

E$/E = PUS/PE where P is the price of the reference commodity basket Rearrange: PUS = (E$/E) x (PE)

Therefore, Purchasing Power Parity (PPP) asserts that all countries' price levels are equal when measured in terms of the same currency.


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