Analyse the purchasing power parity theory

Relative PPP refers to rates of changes of price levels, that is, inflation rates. Nontradables also lead to deviations in PPP because the prices of nontradables are not linked internationally.

For example, if a widget costs Canadian dollars in Canada, the same widget should cost U. The economic forces behind PPP will eventually equalize the purchasing power of currencies. The Big Mac Index will tell you a lot about a country's cost of living.

If dhobis entered into international trade and freely moved into the U. Different methods of calculation will arrive at different PPP rates. By Kimberly Amadeo Updated August 29, Purchasing power parity is a theoretical exchange rate that allows you to buy the same amount of goods and services in every country.

This will create a large demand for rupees in the USA while supply thereof will be less because very few people would export commodities from USA to India. This point is called the purchasing power parity.

Transport costs sever the link between exchange rates and the prices of goods implied by the law of one price. Further, it is very difficult to measure purchasing power of a currency.