Explain Purchasing Power Parity. What will be an ideal response?

Explain Purchasing Power Parity.

What will be an ideal response?

ANSWER

PPP states that the exchange rate between two countries’ currencies equals the ratio of the countries’ price levels.
A fall in a currency’s domestic purchasing power (i.e. an increase in the domestic price level) will be associated with a proportional currency depreciation in the foreign exchange market and vice versa.
= PUS/PE where P is the price of a reference commodity basket.
Rearrange: PUS = × (PE)
Thus, PPP asserts that all countries’ price levels are equal when measured in terms of the same currency.