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Purchasing Power Parity (PPP) is a fundamental concept in international financial management that links exchange rates to price levels between two countries. According to the PPP theory, in the absence of transportation costs and trade barriers, identical goods should have the same price when expressed in a common currency. Essentially, PPP suggests that the exchange rate between two currencies should adjust so that a basket of goods in one country costs the same as an equivalent basket in another country. There are two main forms of PPP: absolute and relative. Absolute PPP asserts that the price of a basket of goods in one country, when converted into another country’s currency at the current exchange rate, should be equal to the price of the same basket in the other country. Relative PPP, on the other hand, focuses on the rate of change, stating that the percentage change in exchange rates between two currencies over time should equal the difference in the inflation rates of the two countries. PPP serves as a tool for assessing long-term equilibrium in currency values and provides _____ __________ ___ ________ _______ ________ __________ _______ _____.
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