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.  Measurable differences in commodity pricing around the globe can assist analysts in determining whether a countries currency is over or under-valued. For example if in May 2008 $1.30 purchased a kilo of flower in the United States and that kilo of flower cost £0.91 in Great Britain, calculating… £0.91 =  £ .70/$ ___________________________________________$1.30 … suggests that the appropriate exchange rate should be £ .70/$.  If the actual exchange rate was £ .60/$.  we must take the difference between the actual and expected rate divided by the expected rate to calculate the following: £0.70 - £0.60 =  16.67% ___________________________________________£0.60 This solution suggests that at that time in May 2008 the British pound was 16.67% overvalued. However this solution does not consider all inputs.  A more commonly used formula known as Relative Purchasing Power Parity takes the inflation rates of any two countries into consideration when calculating the future value of a currency.  For example, if the United States and Australia have annual inflation rates of 3% and 5% respectively and the spot rate of the Aussie Dollar is AU$= $0.85 then the value of the Aussie Dollar in 2 years should be. E2= 0.85(1.03/1.05)^2= $0.8179 This future (expected) rate of $0.8179 for the AU$ in 2 years can then be used in the equation above to determine percentage over/undervalued.     Citation Shapiro, Alan C and Atulya Sarin.  Multinational Financial Management. 6 e.d. NJ.  Wiley & Sons Inc:  2009. Vachris, Michelle A., and James Thomas. "International price comparisons based on purchasing power parity." Monthly Labor Review 122.10 (1999): 3-12. OmniFile Full Text Mega. H. W. Wilson.Pollack Library, Fullerton, CA.18 May 2009 <http://vnweb.hwwilsonweb.com.lib-proxy.fullerton.edu/>.