Answer Posted / khushal
Purchasing Power Parity PPP is a theory which suggests that
exchange rates are in equilibrium when they have the same
purchasing power in different countries.
A very simple example.
Suppose a Big Mac costs £2 in the UK and $4 in the US. The
correct exchange rate according to purchasing power parity
would by £1 in $2. This would leave a customer indifferent
to buying the good in the UK and buying it in the US.
Suppose an Apple Mac costs £1,000 in the UK and $1000 in the
US. An exchange rate of £1 to $2 suggests that it is much
cheaper to buy the Mac in America. Therefore, UK citizens
will want to import the good from America, this will involve
selling pounds and buying dollars causing the Pound to
depreciate.
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