Concept of Purchasing Power Parity
One price in the whole world is the basic concept of
purchasing power parity. If this is not the case then you will be able to
generate risk free return by buying in country and selling in other country.
The price difference in two countries is due to exchange rate.
Example of Purchasing
power parity
A banana cost in united stated 2.5 dollar and the banana of
same quality is sold in UK for one pound. The exchange rate between USA and UK is
USA/UK = 2.5/1.
Limitation of purchasing power
1.
Tariff impact
Due to
different rates of tariff in different country it is not possible to maintain
once price for a product all over the world.
2.
Local Taste Demand
Different
product has different demand in different countries and therefore a standard
price concept is not valid.
