The Purchasing Power Parity is available in both absolute and relative forms. In that it is a dynamic variation of PPP, relative PPP is an extension of absolute PPP.
What is absolute PPP and relative PPP?
- The fundamental PPP principle holds that after two currencies have been exchanged, a basket of commodities should have the same value. This is known as absolute purchasing power parity (APPP). The theory typically relies on translating foreign currencies into US dollars.
- According to the economic theory known as relative purchasing power parity (RPPP), the inflation and exchange rates of two nations should eventually be equal. In that it is a dynamic variation of PPP, relative PPP is an extension of absolute PPP.
- Because the exchange rate is far more volatile than the average price level, relative PPP is not valid at any given time.
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