Purchasing power parity (PPP) is a concept in international economics that determines exchange rate fluctuations over time based on differences in purchasing power and cost of living between countries. PPP holds that identical goods should have the same real price after currency conversion. It aims to measure purchasing power of currencies by comparing the prices of common goods and services in different countries rather than using exchange rates alone. PPP is one of the most significant theories in international finance for understanding how exchange rates adjust to equalize the purchasing power of different currencies.

1. PURCHASING POWER PARITY
Purchasing Power Parity is a concept of
international economics which determines the
changes of exchange rates between the two
currencies over any period of time. Purchasing
Power Parity is also associated with exchange rates
and for the companies operating in the
international level, dealing with the transactions
and economics risks and it is also determined by
exchange rates.
The purchasing power is defined by the “capacity
of purchase of goods and services that can be
obtained from a specific income. This purchasing
power is different in each country with the same
income. Indeed, the cost of living is not the same
everywhere.”

2. According to the traditional PPP theory, as originally
defined by Cassel (1916; 1921)” in perfect goods
and financial markets identical goods must have the
same real price everywhere. Otherwise commodity
arbitrage will take place (Law of One Price).”
Purchasing Power Parity is also one of the most
significant theories of international finance which
explains the theory in very simple form, that PPP
represents the two price indices must have the
same value after the conversion in the same
currency.
PPP is a unit of measurement that allows
comparison of purchasing power of different
currencies. In its calculation, the purchasing power
parity does not take into account the exchange rate
but the cost of living in general through a basket of
goods and services. So, we compare for example the
price of a bottle of Coca Cola in France and in the
United States.