Purchasing Power Parity:

Purchasing power parity (PPP) is a theory which states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries. This means that the exchange rate between two countries should equal the ratio of the two countries' price level of a fixed basket of goods and services. When a country's domestic price level is increasing (i.e., a country experiences inflation), that country's exchange rate must depreciated in order to return to PPP. The basis for PPP is the "law of one price". In the absence of transportation and other transaction costs, competitive markets will equalize the price of an identical good in two countries when the prices are expressed in the same currency. Purchasing Power Parity (PPP) is the economic theory that continuously adjusts exchange rates. Thus, PPP refers to the basket of basic goods that can be bought with the currency of a given country. This theory is based on the 'law of one price', which states that the same product(s) should be priced identically in different markets. Hence, a country witnessing inflation requires a devaluation of its currency in the foreign exchange market, so as to equalize the PPP. Moreover, PPP is known to influence only the long-term exchange rates between countries. PPP helps in identifying the relative values of two currencies. The purchasing power of currencies varies depending on factors such as inflation, cost of living and the demand and supply of goods. The purchasing power parity of a currency differs from the actual market exchange rates. Measuring PPP is a difficult task, given the incomparability of the basket of goods across nations. This is because price differences for certain goods may be greater; the type, quality and quantity of goods in the basket may be different and comparing the data of more than two countries is statistically difficult.