Write an equation that decsribes puchasing power parity and explain the equation.

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Karyth Cara eNotes educator| Certified Educator

Purchasing power parity relates to the currencies of two different countries. "Parity" is defined as two things being in a state of being equal: equal value between two things. In economics, when currencies are in parity, the ratio of the price level of a fixed basket of the goods and services in each country (e.g., basket price level of bread, butter, fabric, machiine oil, education) is equal in value to the ratio of the countries currency.

Purchasing power parity (PPP) ... states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries. ... the exchange rate [ratio] between two countries should equal the ratio of the two countries' price level of a fixed basket of goods and services. (University of British Columbia)

Purchasing Power Parity (PPP) is calculated as:

S = P1/P2

S: exchange rate of currency 1 to currency 2
P1: cost of good A in currency 1
P2: cost of good A in currency 2 (Investopedia.com)