Relative Purchasing Power Parity (RPPP)

What Is Relative Purchasing Power Parity (RPPP)?

Relative purchasing power parity (RPPP) is an expansion of the traditional purchasing power parity (PPP) theory to remember changes for inflation over the long run. Purchasing power is the power of money communicated by the number of goods or services that one unit can buy, and which can be reduced by inflation. RPPP recommends that countries with higher rates of inflation will have a devalued currency.

Understanding Relative Purchasing Power Parity (RPPP)

   As per relative purchasing power parity (RPPP), the difference between the two countries' rates of inflation and the cost of commodities will drive changes in the [exchange rate](/exchangerate) between the two countries.

RPPP develops purchasing power parity and supplements the theory of absolute purchasing power parity (APPP). The APPP concept declares that the exchange rate between the two nations will be equivalent to the ratio of the price levels for those two countries.

Purchasing Power Parity in Theory

Purchasing power parity (PPP) is the possibility that goods in a single country will cost a similar in another country, when their exchange rate is applied. As per this theory, two currencies are at par when a market basket of goods is valued similar in the two countries.

The comparison of prices of indistinguishable things in various countries will decide the PPP rate; be that as it may, an accurate comparison is troublesome because of differences in product quality, consumer mentalities, and economic conditions in every nation. Likewise, purchasing power parity is a hypothetical concept that may not be true in reality, particularly in the short run.

Dynamics of Relative Purchasing Power Parity (RPPP)

RPPP is basically a dynamic form of PPP, as it relates the change in two countries' inflation rates to the change in their exchange rate. The theory holds that inflation will reduce the real purchasing power of a nation's currency.

In this manner in the event that a country has an annual inflation rate of 10%, that country's currency will actually want to purchase 10% less real goods toward the finish of one year.

RPPP likewise supplements the theory of absolute purchasing power parity (APPP), which keeps up with that the exchange rate between two countries will be indistinguishable from the ratio of the price levels for those two countries.

This concept comes from an essential thought known as the law of one price. This theory states that the real cost of a decent must be something similar across all countries after the consideration of the exchange rate.

Illustration of Relative Purchasing Power Parity (RPPP)

Assume that throughout the next year, inflation causes average prices for goods in the U.S. to increase by 3%. In similar period, prices for products in Mexico increased by 6%. We can say that Mexico has had higher inflation than the U.S. since prices there have risen quicker by three.

As per the concept of relative purchase power parity, that three-point difference will drive a three-point change in the exchange rate between the U.S. also, Mexico. So we can anticipate that the Mexican peso should depreciate at the rate of 3% each year, or that the U.S. dollar ought to appreciate at the rate of 3% each year.

Features

• Relative PPP is an extension of absolute PPP in that it is a dynamic (rather than static) variant of PPP.
• Relative purchasing power parity (RPPP) is an economic theory that states that exchange rates and inflation rates (price levels) in two countries ought to rise to out over the long haul.
• While PPP is valuable in understanding macroeconomics in theory, in practice RPPP doesn't appear to hold true throughout short time skylines.

FAQ

What Country Has the Highest Purchasing Power?

Switzerland has the highest purchasing power starting around 2022, with a purchasing power index number of 118.4. Following Switzerland, the U.S. has the second-highest purchasing power, with an index number of 106.34. Nigeria has the lower purchasing power, with an index number of 9.34.

What Is the Formula for Purchasing Power Parity (PPP)?

The formula for purchasing power parity (PPP) is Cost of Good X in Currency 1/Cost of Good X in Currency 2. This permits an individual to create comparisons of currencies and the value of a basket of goods they can buy.

Why Is Purchasing Power Parity (PPP) Important?

Purchasing power parity (PPP) is important in light of the fact that it permits business analysts to compare two distinct economies, essentially the economic productivity and the standard of living among nations. It looks to balance currencies to decide the value of a basket of goods.