What is Purchasing Power Parity

The three P's, that is Purchasing Power Parity, refers to a simple argument that goes as follows: currencies that are experiencing a high degree of inflation will tend to devalue to maintain their relative purchasing power across different currencies.

This is called sometimes the law of one price. There are problems with this market however such as it assumes the same amount of purchasing weightings across all countries, something that is manifestly not actually the case.

If one were to use absolute Purchasing Power Parity then you would actually need to use the price indices for each country that is concerned which would then reflect the weighting of goods in that country.

Therefore there is another model that is called Relative Purchasing Power Parity and this time it does not focus on the absolute price levels as per the other model.

Instead of this what does it look at?

Well the answer is that it looks instead at changes in purchasing power by looking very much instead at the inflation rates.

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