Why might purchasing power parity fail to hold?

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Why might purchasing power parity fail to hold?

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Why might purchasing power parity fail to hold?

Explanation & AnswerSolution by a verified expert

Explanation

PPP is the theory that goods in different countries have the same value after the exchange rate is accounted for. The reason that this theory may fail to hold is because there are many variables that need to be considered when comparing goods produced in different countries. Such variables can include quality, demand, availability, economic conditions, and purchasing habits. If any of these variables are not consistent in both countries, then the value of a product may not be equal even after the currency exchange rate is considered.

Verified Answer

The key to purchasing power parity (PPP) requires certain assumptions to be made. The first is that governmental regulations do not impact the ability to buy goods in one nation or another. Furthermore, PPP assumes that the products in each country are identical. In addition, PPP factors out any transaction costs that may occur. If any of these assumptions exist, the PPP will be invalid as an economic measure.

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