Answered: Explain the concept of purchasing power…

Business

Economics

Explain the concept of purchasing power parity.

Macroeconomics

13th Edition

ISBN:9781337617390

Author:Roger A. Arnold

Publisher:Roger A. Arnold

Chapter22: International Finance

Section: Chapter Questions

Problem 7QP

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Question

Explain the concept of purchasing power parity.

Definition Definition Value of one unit of currency in terms of goods and services. Purchasing power refers to the ability of money to purchase goods and services at a particular point of time. As price levels in the economy increase, the purchasing power of one unit of currency decreases and vice versa.

Expert Solution

Step 1

When the part exchange of currencies takes place between two or more
countries, purchasing power parity theoryis beneficial in this context. It
is based on the law of one price which means that the retail (selling)
price of the product will be similar in two different markets excluding
the variations in transportation cost and other taxes.
The implementation of PPP theory will1 be beneficial both during the
short run as well as the long run, but more benefits can be witnessed in
the long run eventually. PPP theory helps in comparing price differences
and rates over daily, weekly and yearly periods between two countries
over the short run to the long run.

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