Purchasing Power Parity (PPP) is an economic theory that states that the exchange rate between two currencies should be equal to the ratio of the two countries' price levels for a basket of goods and services. In other words, PPP suggests that the same goods and services should cost the same in different countries when the prices are expressed in the same currency.For example, if a basket of goods and services costs $100 in the United States and €100 in the European Union, then according to PPP, the exchange rate between the U.S. dollar and the euro should be 1:1. If the actual exchange rate is different, then PPP suggests that one currency is overvalued or undervalued relative to the other.PPP is often used as a theoretical benchmark for comparing the relative purchasing power of different currencies and to predict the long-term direction of exchange rates. It is based on the idea that, in the long run, exchange rates should reflect differences in the price levels of goods and services in different countries, rather than being influenced by short-term factors such as interest rates or inflation.PPP is not always a perfect predictor of exchange rates, as it does not take into account other factors that can influence exchange rates, such as differences in productivity, inflation, or trade balances. However, it is still a widely used concept in economics and can provide useful insights into the relative value of different currencies.
