International-Business-Dr-R-Chandran-E-book

Factor
Conditions
PURCHASING POWER PARITY
Firm Strategy,
Structure and
Rivalry
Related and
Supporting
Industries
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International Business- Dr. R. Chandran
Demand
Conditions
The PPP was formulated by Gustan Cassel in the year 1920, when inflation
was high. It represents a synthesis of the work done by economists like
David Ricardo, Wheatley and Henry Thorton in the nineteenth century.
The theory puts forward the idea that when currencies are exchanged among
nations, their purchasing power is only transferred. This means that we
should be able to buy the same amount of goods in either country, when
expressed in either country’s currency because people value currencies for
what they pay.
The theory suggests that the principle determinant of exchange rate is the
difference in National Inflation Rates. This means, a country, where costs
and prices are relatively less than other country will find its currency
appreciating. The sole focus on inflation differentials among countries is the
dominant factor that explains the movements in the exchange rates and also
indicates why the spot rate is what it is at a given point of time.
The law of one price is usually the basis to interpret the theory. According to
this law, after making allowances for tariff and transport costs, the price of
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