Question

Why does the PPP theory not hold in reality?

Answer 1

The PPP theory does not hold in reality because of following reasons :-

1. It assumes all goods are traded internationally but in reality there are many goods which are not traded. As these are not traded they may not change the exchabge rates or prerequisite of the PPP theory.

2. The ppp theory assumes that there are no transaction costs but in reality there are transaction costs.

3. Countries that experience rapid technological development may see rapid appreciation of their currency over time

I hope this helps

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