Published Oct 25, 2023 Relative Purchasing Power Parity (RPPP) is an economic theory that states that the exchange rate between two countries should adjust to reflect changes in the price levels of those countries. According to RPPP, if there is a difference in inflation rates between two countries, the currency of the country with a higher inflation rate will depreciate relative to the currency of the country with a lower inflation rate. This theory suggests that exchange rates should change in order to maintain equality in purchasing power across different countries. To understand RPPP, consider two countries, Country A and Country B. Suppose the price level in Country A is increasing at a higher rate than in Country B due to higher inflation. According to RPPP, the currency of Country A will depreciate relative to the currency of Country B to reflect the difference in inflation rates. This means that goods and services in Country A will become relatively cheaper compared to Country B, leading to an increase in demand for Country A’s goods and a decrease in demand for Country B’s goods. As a result, the exchange rate between the two countries will adjust to maintain the relative purchasing power of their currencies. For example, if 1 unit of Country A’s currency could buy 2 units of Country B’s currency initially, but due to higher inflation in Country A, the exchange rate changes to 1 unit of Country A’s currency buying 1.5 units of Country B’s currency, then the relative purchasing power is maintained. Relative Purchasing Power Parity is an important concept in international trade and finance. It helps explain how exchange rates are influenced by inflation rates and price levels across different countries. Understanding RPPP is crucial for businesses engaged in cross-border trade as it allows them to anticipate and plan for changes in exchange rates. It also has implications for investors and policymakers, as exchange rate movements can impact inflation, trade balances, and economic competitiveness. RPPP serves as a useful tool for analyzing and predicting currency movements and their effects on global markets.Definition of Relative Purchasing Power Parity (RPPP)
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Why Relative Purchasing Power Parity Matters
Economics