Relative Purchasing Power Parity (RPPP)

Relative Purchasing Power Parity (RPPP) is a theory in economics that states that the exchange rate between two currencies will adjust in the long run to equalize the purchasing power of the two currencies. This means that if a dollar can buy more goods in one country than in another, the dollar will be worth more in that country's currency.

RPPP is based on the law of one price, which states that if two goods are identical in every way except for their location, they should have the same price in both locations. If the price of a good is higher in one location than in another, it will be profitable to buy the good in the cheaper location and sell it in the more expensive location. This will cause the price of the good to rise in the cheaper location and fall in the more expensive location, until the prices are equalized.

In the case of currencies, RPPP states that if a dollar can buy more goods in one country than in another, the dollar will be worth more in that country's currency. This is because it will be profitable to buy goods in the cheaper country and sell them in the more expensive country. This will cause the value of the dollar to rise in the cheaper country and fall in the more expensive country, until the prices of goods are equalized.

RPPP is a useful tool for understanding how exchange rates work and for making predictions about future exchange rates. However, it is important to note that RPPP is not always accurate. There are a number of factors that can cause exchange rates to deviate from RPPP, such as differences in interest rates, inflation rates, and government policies.

Despite these limitations, RPPP is a valuable tool for understanding the relationship between exchange rates and purchasing power.