Notes On Purchasing Power Parity

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Purchasing power Parity (PPP), is a theory stating that the unit of one currency should have the same purchasing power as the foreign currency. Following the theory, where the normal exchange rate between two currencies should be the same as the ratio of aggregate price level between them. It can be also called “inflation theory of exchange rates” as it stands for the theory of a change of price level where as the overriding determinant of exchange rate movements. It is the same status as Quantity theory of money(QT). To make things clear, the dogma of PPP or its alternative Law of one Price (LOOP), states that when goods in the basket expressed in a single currency meaning that they cost the same in all countries. This can be achieved only if the rate or nominal exchange rate is equal to the differences between growth rate. The dental of LOP context is to find the most disaggregate product and price can be readily material-provides as strong presumption that it is impossible to assemble available date into aggregate price index which can be expected to obey the LOP.

It is introduced in 1918 by Cassel, due to World War I, while there was an international policy debate about the appropriate level for nominal exchange rates among countries after the large scale of inflations. Rogoff (1196), expressed that some economists takes PPP seriously in the Short Run(S/R), but the red variant of PPP, is in the long run exchange rate. Dornbusch and Krugman (1976) also,
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