Rate of exchange = PI / PA
Where,
PI = Prices
of certain goods in India
PA = Prices of same goods in another country, say USA.
Thing to note is that, the changes
in internal price level
cause changes in the exchange rate. if inflation is India, then the
purchasing power of rupee in terms of dollars would decline. It is
not easy to measure the value of money in absolute terms.
2. Relative version:
In this method the changes in the purchasing power can be
measured by the changes in the indices
of domestic prices of the
countries concerned. Hence the changes in the equilibrium rate can
be measured by the ration of the price indices of the respective
countries. in this new equilibrium rate of exchange can be
calculated by multiplying the base period
of rate exchange by the
relative changes in the price levels in the two countries with the
help of index numbers.
Evaluation of PPP theory:
It is based on the unrealistic assumption that international
trade is free from all barriers.
This theory does not explain
the demand for supply of
foreign exchange. While in the free economy the rate is
determined by the forces of demand and supply of foreign
exchange.
The quality of goods and services may vary from country to
country, so comparison of prices without regard
to the quality
is unrealistic.
Cost of transport is ignored in this theory.
It also ignores the impact of international capital movement
which affects on the foreign exchange market.
The price index number includes the price of all commodities
and services, including those which
are not internationally
traded and hence the rate of exchange calculated on the
basis of these price indices cannot be realistic.
Do'stlaringiz bilan baham: 
