(8 of 18) Ch.21 - Relative purchasing power parity

Relative Purchasing Power Parity is a formula that shows how expected future exchange rate between two currencies should depend on what today's exchange rate is, as well as the difference between the foreign and the domestic expected inflation rates.
For example, if the the cost of living is expected to increase by a lot more in Mexico than in the USA, then in order for the purchasing power of the US dollar to remain unchanged, each US dollar should be exchangeable into more Mexican Pesos. A 50% higher increase in the cost of living should result in a 50% higher exchange rate (i.e., 50% more Pesos per US$ 1).

[@patrickchen7898]

you're an amazing professor. thank you!

[@mindloop4070]

excellent explaination...this is the best way to understand relative ppp concept...lot of others youtube tutor either failed or are not able to understand this concpet properly to others...

[@kevinriahi3012]

Thank you so much for creating so many great videos. My uni professor is a smart person but a really bad teacher. So your youtube videos are great revision material!

[@lokiendgame231]

Does relative PPP’s exchange rate not use the ratio derived from comparing 2 commodities? Does it instead use the fluctuating market exchange rate?

[@teachmefinance9453]

Prices for 2 commodities are used in the "ABSOLUTE PPP" formula (not "relative PPP" formula). For example, the "absolute PPP" says that the following should be true: Price for a burger in Japan = Price for the same exact burger in the USA X Exchange rate expressed as Japanese Yen per one US dollar. This formula can be rewritten exactly like you said: Exchange rate in terms of Japanese Yen per one US dollar = Price for a burger in Japan / Price for the same exact burger in the USA.

[@lokiendgame231]

Thanks for answering😀. But I’m wondering if the spot exchange rate you used to convert Japanese Yen to Dollar in the video above is from comparing 2 identical commodities and finding the ratio between them.

[@lokiendgame231]

Basically, where is the exchange rate used in the RPPP calculation from? Is it from comparing 2 commodities or from the foreign exchange market?

[@teachmefinance9453]

@@lokiendgame231 It's from the foreign exchange market. It's given.