Explain why Relative PPP is useful when comparing countries that base

Explain why Relative PPP is useful when comparing countries that base their price levels on different product baskets.

What will be an ideal response?

ANSWER

For Example: If the U.S. price level rises by 10% over a year while Europe’s rises by only 5%, relative PPP predicts a 5% depreciation of the dollar against the euro. This just cancels the 5% by which U.S. inflation exceeds European, leaving the relative domestic and foreign purchasing powers of both currencies unchanged.
( – )/ = ( )US,t – ( )E,t between dates t and t – 1.
Relative PPP is useful when comparing countries that base their price levels on different product baskets. Relative PPP may be valid even when absolute PPP is not.