The Purchasing Power of Parity Theory asserts that the purchasing power of one unit of ‘home currency’ should be equivalent worldwide.  In other words, if one U.S. dollar can purchase a commodity (such as 1 pound flower) in the United States, it should be able to purchase the same item using one U.S dollar worldwide.  When this is not the case, prices are in disequilibrium and there may be opportunity for arbitrage. 

Purchasing Power Parity (PPP) is a theory which states that exchange rates between two currencies are in equilibrium when their purchasing power is the same in each of the two countries. In essence, the ration of the two countries’ price level for a particular good is the same as the exchange rate between the two countries. For example, McDonalds is a very popular fast food chain that is in countries worldwide.

Purchasing Power Parity bears an important message. Exchange rates movements should just cancel out changes in the foreign price level relative to the domestic price level.  Then investopedia also explains the exchange rate adjusts so that an identical good in two different countries has the same price when expressed in the same currency. Theses offsetting movements should have no effects on the relative competitive positions of domestics firms and their foreign competitors .

The purchasing power parity, as known as PPP, is one of the parity conditions result from arbitrage activities. The purchasing power parity specifies that the spot exchange rate between currencies will be adjusted based on the differences of inflation rates between countries. There are some of the things that arbitrager has to take into consideration such as the law of one price, time period, spot rates, and inflation rates while using the theory of purchasing power parity to help forecast currency exchange rates.

Purchasing power parity (PPP) states that exchange rates between currencies are in equilibrium when their purchasing power is the same in the two countries. This means that the exchange rate between two countries should equal the ratio of the two countries' price level of a fixed basket of goods and services. When a country's domestic price level is increasing, that country's exchange rate must depreciate in order to return to PPP.

Purchasing power parity is economic technique used to determine relative value of two different currencies. PPP is often used to forecast future exchange rates for purposes ranging from deciding on the currency denomination of long-term debt issues to determining in which countries to build plants. It also states that home currency in this case we would assume United States should have the same purchasing power around the world. Example that is used in all major text book is Big Mac which currently sells in 120 countries.