Purchasing power parity

Purchasing power parity is an exchange-rate relationship in which currencies buy equivalent baskets of goods. It is used to compare price levels and explain long-run currency values.

Law of one price: The principle that identical tradable goods should have the same price across markets when expressed in a common currency. Purchasing power parity extends this single-good principle to baskets of goods.
International dollar: A hypothetical currency unit used to compare purchasing power across countries at a common price level. It converts national spending into comparable amounts using purchasing-power adjustments.
Nominal exchange rate: The rate at which one currency can be exchanged for another, without adjustment for price levels. It is the observed currency price that parity estimates seek to interpret.
Price stickiness: The tendency of prices to adjust slowly in response to changing economic conditions. Slow price adjustment can delay the movement toward purchasing-power parity.
Gustav Cassel: A Swedish economist who popularized the term purchasing power parity in the early twentieth century. Cassel made parity a framework for discussing postwar currency values.
Absolute purchasing power parity: The claim that exchange rates equal the ratio of countries’ price levels for comparable baskets. This is the direct basket-price version of the parity relationship.
Penn World Table: A global dataset of national accounts, output, prices, and productivity measures adjusted for international comparability. Its purchasing-power estimates enable comparisons of economies’ real output.
Interest rate parity: A relationship linking exchange rates and interest rates across countries through financial-market returns. Unlike purchasing power parity, it centers on financial assets rather than goods prices.
Transaction cost: A cost incurred when exchanging goods, services, or financial assets. Transport, tariffs, and other costs create a band within which price gaps can persist.
David Ricardo: A British political economist whose theories include comparative advantage and international trade. His account of trade and price adjustment helped shape later exchange-rate reasoning.

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