Basic Principles of Purchasing Power Parity

The purchasing power parity theory is based on the so-called "Law of One Price". This law states that, in the absence of barriers, the price of the same good should be the same everywhere after adjusting for exchange rates.

Imagine you want to buy a new smartphone. If the same smartphone sells for $500 in the United States and ¥55,000 in Japan, then according to purchasing power parity theory, the exchange rate should be $1 to ¥110. It's simple, right?

Of course, the reality is not that straightforward. Factors such as taxes, transportation costs, and local demand cause the prices of goods to vary by region. Therefore, economists do not focus on just one good but rather on a basket of goods, which includes a range of products that people in different countries/regions typically buy, like food, clothing, housing, and energy. By comparing the prices of a basket of goods, one can understand the relative strength of different currencies.#BabyMarvinf9c7牛市新星⭐