Explain in details the purchasing power parity theory.?

Question

Internal economics

Answer 1

The PPP basically says that the exchange rates should adjust such that the price of a product should be the same across the world (ignoreing transportation costs).

So if a chair costs 5 Euros in Italy, and 2$ in Australia, then the PPP says that the exchange rate should be 2.5 Euros to the Australian dollar.

Obviously using a chair is a trivial expamle, but it should apply across the broad range of goods,

If say the exchange rate was 1 Euro to an Australian $, then people would buy chairs in Australia and sell them in Italy. Buying stuff in Australia, causes the demand for AU$ increases and selling stuff in Italy increases the supply of Euros, therefore AU$ get 'more expensive' with respect to the Euro; the AU$ appreciates with respect to the Euro.

This should continue until it 2.5 Euros to an AU$.

You can factor in transport costs, and other rigidities, but that's the general idea. The key is that arbitrage.

Answer 2

as the answer before mine show the purchasing power parity is less a theory than a statistical method and a policy prescription.
For instance all those who have been to India or China know that their money are way too low. You can buy things in china or india about 5 times cheaper. Of course some things are more expensive. THat is why those who work on purchasing power parity have to take into account the fact that chinese and americans do not spend their money on the same products. FOr instance a big mac is not included in the basic chinese meal so comparing big macs only would be misleading. It s possible to compare how much the stuff the typical chinese buys cost in the USA, and how much the stuff th typical american buys cost in China. And the problem is of course that both method tend to make the other country more expensive (since rarer products are often more expansive). I m not aware of the exact details on how such statistic technic questions are resolved when PPP comparisons are made.
Anyway the recent years have proven one thing the "theory" that says that exchanges rates do fluctuate around the PPP has been proven false. Asian countries have kept underevalued currencies for decades now.
However that does not mean that the policy prescription is not wise, since those policies of underevaluating currencies are having major destabilising impacts.

Answer 3

PPP doesn't claim that currencies will adjust so that things cost the same in different countries (as far as I know), rather it is an attempt to make sense of what's really being produced and purchased in different countries so that one can make comparisons, given that there are in fact great price differences in many goods.

Example: given current exchange rates, an Indian buffet lunch in the UK costs $25, but in the US it only costs $10 (trust me on this, I know). It took about the same amount of labor and energy to produce the food. So does it make sense to say that that one hour of labor in the UK produces $25 of output, but in the US it only produces $10 of output, indicating the UK is much more productive? No -- that's not very meaningful. Adjusting things for PPP gives a more meaningful analysis.

Answer 4

PURCHASING POWER PARITY allows the comparison of standard of living between countries by adjusting the exchange rate to an equal value across countries...

look at the big mack index., itz basically comparing the price of big mack in different countries( since mcdonalds is in most countries) look at it then you'll understand.,

Answer 5

below you'll locate an outline of the video clips and different content that pertain to a everyday introductory microeconomics route. i desire you'll peruse at your leisure and with somewhat of luck study something contained in the approach! I welcome comments and recommendations, so please go away them below once you've them.