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Critically evaluate the concepts of absolute and relative purchasing power parity.
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Critically evaluate the concepts of absolute and relative purchasing power parity. 1. Introduction There are many factors which influence the exchange rates however, many economists consider that there is one factor which is of particular importance in analysing the changes in exchange rates and that is inflation. The theory behind the long-run connection between inflation and exchange rates is known as the purchasing power parity (PPP) principle. The concept was enforced by Gustav Cassell in the 1920's and plays a key role in international money and finance. Although there has been much controversy surrounding the validity of PPP, the general consensus is that this theory does bring to light some important aspects surrounding exchange rate movements. According to Johnson (2000), PPP is defined as, 'The concept that homogenous goods can not have more than one price measured in any one currency. If the price increases domestically, the domestic currency will depreciate so that the...
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