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Hello,
When we talk of PPP in F9, we are talking of relative PPP and not absolute PPP,right?
It is not a question of relative or absolute.
The PPP formula allows to us to forecast the future exchange rate (on the assumption that the purchasing power of the two currencies will remain the same).
I do suggest that you watch the free lecture on this – our lectures are a complete course for F9 and cover everything you need to pass the exam well.
I think he was asking relating to:ABSOLUTE PPP is a theory which states that the exchange rate is in equilibrium when the purchasing power is the same in each of the two countries. This means that the exchange rate should equal the ratio(Like the example you do in AFM CHAPTER 22) of the two countries’ price level of a fixed basket of goods and services. When a country’s domestic price level is increasing (i.e. there is inflation), that country’s currency must depreciate in order to return to PPP.
and RELATIVE PPP does not state what determines the absolute level of the exchange rate, but rather, what determines the change in the exchange rate over time; that is, relative PPP refers to changes in price levels (inflation rates). This proposition states that the rate of appreciation of a currency is equal to the difference in inflation rates between the two countries.
I don’t know why you have posted this – partly because the question was asked 4 years ago, but mainly because it is asked in the Paper FM Ask the Tutor forum and in Paper FM absolute and relative are of no relevance. As I replied before, everything needed on PPP for the exam is covered in my free lectures.
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