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Purchasing Power Parity Case Study

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1) T he theory of purchasing power parity has 2 different perspectives: we have the absolute form and the relative form. The absolute form states that prices for the same products in two different countries should be equal, when they are calculated on the same currency. The relative form states that the prices for the same products in two different countries will not be the same due to market imperfectations. Assume that we have two countries A and B with respective inflation rates at 0,1% and 16,6% with different currencies. The difference in the inflation rates is 16,5% which means that the country with the lower inflation rate (country A) should appreciate its currency almost 16,5 percent or for country B to depreciate its currency at the same percentage.
2) Assume that we have two countries: Germany and Russia. Germany has an inflation rate at 0,40% and Russia has at 16,40%. Germany imports from Russia will increase and respectively Germany exports to Russia will decrease. This procedure leads to the appreciation of russian ruble this …show more content…

The two countries have different currencies. If the exchange rate of the currencies for the countries remains constant, the consumers will prefer to buy foreign products that home products because their purchasing power is greater for foreign products. In this case ppp does not exists. In the second case, assume the opposite, that the home inflation rate is lower that the foreign one. If the exchange rate remains constant, the consumers will prefer home products than foreign due to the fact that their purchasing power is bigger for home products. Also in this case ppp does not exist. Therefore, for ppp to exist, it is required that the exchange rate between the two currencies will fluctuate equiproportionally with the actual prices paid for specific goods and

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