PPP Theory

Purchasing Power Parity (PPP) theory suggests that in the long run, exchange rates between countries adjust so that identical goods cost the same amount when priced in a common currency. Essentially, it means that inflation rates influence how currencies fluctuate over time, preventing persistent price differences for the same products across borders. If one country experiences higher inflation than another, its currency should weaken to maintain relative price equality. PPP helps explain and predict exchange rate movements based on differences in price levels and inflation, promoting the idea that, over the long term, currencies should reflect the purchasing power of their economies.