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Explain the Basic Logic of Purchasing-Power Parity (PPP) and its affect on exchange rates?

Explain the Basic Logic of Purchasing-Power Parity (PPP) and its affect on exchange rates?

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Answer) Purchasing power parity (PPP) is an economic theory that allows the comparison of the purchasing power of various world currencies to one another. It is a theoretical exchange rate that allows you to buy the same amount of goods and services in every country.

The theory of purchasing power parity (PPP) states that the ratio of price levels between two countries is equal to their exchange rate. Inflation, the general increase in prices, is inversely related to exchange rates: as one goes up, the other must go down to maintain equilibrium.

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