Answer to Question #107794 in Finance for Aliyu Musa Garba

Question

what is PPP and there are two types: Absolute and Relative explain

Answer 1

Purchasing Power Parity (PPP) is a popular metric usually used to measure or estimate the economic productivity and standards of living between two countries i.e cross-country economic analysis. The approach compares the price of a basket of goods in one country to the price of the same basket of goods in another country.

Absolute Purchasing Power Parity – It explains that the exchange rate is at equilibrium when the value of a basket of commodities in one country, A, is equal to another country, B. It assumes that market forces play a vital role of adjusting the exchange rate when the value of national baskets are not the same.

For example: Value of a basket in A = Value of basket in B multiplied by Exchange rate

Thus, Exchange rate = Value of basket in A divided by Value of basket in B

Relative Purchasing Power Parity – It explains how inflation rates and cost of commodities between two countries will influence changes in the exchange rate.