Question

10. What is the rationale for using PPP as a currency trading rule

Answer 1

Purchase Power Parity is one of the most important theories of economics. It states that the compared currencies should be at equilibrium when compared through a basket of goods. It should be of the same value keeping currency exchange rate in mind. Its mainly used by macro-economics to compare the economic productivity and the standard of living between the two compared countries. Some countries also adjust the GDP to reflect the PPP.

For example: if a jeans is available in US for $10 and the exchange rate between US-EURO is 0.75 Euro per USD, so the jeans should be available in Europe for $7.5. if the cost of jeans in less in Europe traders will buy jeans in Europe and sell in US.

The reason for using PPP is that usually the inflation and the GDP is calculated by the goods produced and the price of these goods increased or decreased. If we use PPP then the comparison of GDP and inflation becomes easier as we are comparing two similar goods like apple or jeans or tomatoes price across these two countries.