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Ppp – Purchasing Power Parity
Purchasing Power Parity (PPP) is a macroeconomic theory that relates the prices of goods and services in different countries to their relative purchasing power parity.
Key Concepts:
- Purchasing Power Parity (PPP) is a theory that the prices of identical goods and services in different countries should be equal after adjusting for the differences in cost of living.
- Relative Purchasing Power Parity (RPPP) holds that the prices of goods and services in different countries will converge over time to their relative purchasing power parity.
- The Law of One Price: If a good is sold at the same price in two different countries, then the cost of living in those two countries must be equal.
Assumptions:
- Arm’s Length Transactions: Prices are determined in arm’s length transactions, where buyers and sellers are free to choose their own partners.
- Common Market: Goods and services are traded in a single, competitive market.
- No Transportation Costs: Transportation costs are negligible.
- Homogeneous Goods: Goods and services are homogeneous, meaning they are identical in quality and quantity.
Evidence:
- Purchasing Power Parity (PPP) Index: The World Bank calculates a PPP index that compares the cost of living in different countries to the cost of living in the United States.
- International Comparisons: Studies have shown that PPP holds approximately for a wide range of goods and services.
- Convergence: Over time, prices in different countries tend to converge to their relative purchasing power parity.
Implications:
- Exchange Rates: PPP can help explain fluctuations in exchange rates.
- Inflation: PPP can help predict inflation rates in different countries.
- International Trade: PPP can influence international trade patterns.
Criticisms:
- Time Lag: PPP may not hold true in the short run, as it can take time for prices to converge.
- Non-Traded Goods: PPP does not consider non-traded goods, which can bias results.
- Quality Differences: Differences in product quality can affect prices.
- Market Distortions: Market distortions, such as subsidies, can distort PPP.
Conclusion:
PPP is a powerful macroeconomic theory that provides insights into the relationship between prices and purchasing power parity. While it is not a perfect theory, it can be a valuable tool for understanding international economic dynamics.