purchasing power parity: a standalone construct

Gustav Cassel gave the doctrine its modern name and formal statement in a 1918 paper in The Economic Journal, arguing that the equilibrium exchange rate between two currencies equals the ratio of their price levels, with earlier roots in the sixteenth-century Salamanca school; the idea is that once prices are expressed in a common currency, a basket of tradable goods should cost about the same in every country. Bela Balassa's 1964 reappraisal refined the doctrine by explaining why it fails systematically for whole economies: countries with higher productivity in traded goods tend to have higher price levels overall, because non-traded services carry those wage gains, so measured price levels diverge from the simple parity prediction. Absolute purchasing power parity compares the level of prices, while relative purchasing power parity holds that changes in the exchange rate track the difference in inflation between the two countries. The construct is a landmark because it supplies the long-run benchmark against which real exchange rates, currency misalignment, and cross-country income comparisons are measured, and it underlies the price surveys used to convert national output into internationally comparable terms.[1][2][3]

Unit

A parity condition relating two countries' price levels to their nominal exchange rate, stated as an exchange rate or a ratio of price indices

Recovery means

Not applicable

Measured by

Tested by comparing national price indices converted at market exchange rates, or estimated from cross-country price surveys such as the World Bank International Comparison Program