Purchasing power Parity (PPP), is called relative purchasing power index which is according to different countries pricing level to calculate out an equivalent index value for different currencies. It helps able to compare the GDP of counties from the economics view, although there is a great difference between theoretical exchange rate and the actual exchange rate. The unit for the PPP theory is international dollar (Intl. $) or international currency unit (ICU). The PPP is dollar-based, that the purchasing power of $ 1 in the United States as a reference base. It is an international purchasing power of the dollar is equal to $ 1 in the United States. In many cases, the direct use US dollar as PPP index. The theory…show more content… The value of a country's needs and its currency is the amount of goods and services by a unit of currency in the country can buy decision, namely the decision by its purchasing power, and therefore the exchange rate between two currencies can be expressed as the ratio of the purchasing power of the two currencies. However, the size of the purchasing power is reflected by the price levels. Based on this relationship, domestic inflation will mean their currencies depreciate relative to foreign currencies. Relative PPP definitely makes up for some deficiencies in terms of purchasing power parity. Its main points can be simply stated as: currency exchange rate between the two countries will be based on the difference between the two countries the rate of inflation and adjust accordingly. It shows the relative inflation equilibrium exchange rate between the two countries decide between two…show more content… The main factor is the relative change in the exchange rate or price changes in currency purchasing power across countries; compared with the exchange rate at the balance of the period, when the ratio of the two changes in purchasing power. Currency exchange rate between the two countries must be adjusted.
The relationship between absolute PPP and relative PPP, if the absolute purchasing power parity is applicable, the relative purchasing power parity is necessarily true, because the price index is two points in the ratio of the absolute level of prices. Alternatively, if the relative purchasing power parity is applicable, absolute purchasing power parity is not necessarily true.
PPP theory is highly applicable for some reasons. The purchasing power of the two currencies between the two countries can decide their currency exchange rate. This is actually to analysis the value of the currency to decide exchange rate. It captures the main direction of exchange rate movement so that to ensure the direction is correct. If a given fixed value, the difference between the two countries in purchasing power actually represents the difference between values of the two currencies. The ratio of purchasing power of the two countries is the ratio of the two currencies value. Thus the two exchange rates can be expressed in some way by the purchasing
