Read full document


Page 1 of 7

Joanna Wazny
University Of The West Of Scotland

Purchasing power parity
Purchasing power parity theory is used to examine and contrast different Currency. Purchasing power parity (PPP) is the economic concept and the method used for determining the comparative value of currencies, evaluating the sum of adjustment required on the exchange rate between states sequentially for the exchange being equal to (or on par with) purchasing power of every currency (Balassa, 2004). This theory asks how much capital would be required for purchasing the similar goods and services in 2 states, and utilizes that to estimate the implicit foreign exchange rate (Redding, 2000). By means of that purchasing power parity rate, the amount of capital therefore has the similar purchasing power in different states. Amongst other uses, PPP rates make possible global evaluation and contrast of profits, as marketplace exchange rates are frequently unstable, are influenced by political as well as financial factors which don’t cause direct changes in income and are liable to methodically minimize the standard of living in under-developed states (Patel, 2000).

The theory of purchasing power parity may be divided into 2 types namely: ➢ First is the theory of absolute purchasing power parity ➢ Whereas the other one is relative purchasing power parity theory The formula of the absolute purchasing power parity theory is S = P / P*,

Where S is the exchange rate, P and P* stand for the level of regional and foreign price of the same collection of products in that order (Mark, 1995). The absolute PPP indicates that when the level of domestic price raises comparatively, the domestic currency’s purchasing power falls down consequently (Alan, 2004). That is, the currency diminishes and the exchange rate declines, and on the contrary. Whereas the formula of the relative...