What do you understand by Purchasing Power Parity (PPP) and Interest Rate Parity (IRP)? Explain with examples.

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Purchasing Power Parity (PPP) and Interest Rate Parity (IRP) are two important concepts in the field of international finance that help to explain the relationship between exchange rates, interest rates, and prices. Here is an explanation of what PPP and IRP mean, and how they work:

Purchasing Power Parity (PPP):
PPP is a theory that suggests that in the long run, exchange rates between two countries should adjust to equalize the prices of goods and services. This means that if the exchange rate between two currencies is not in line with the relative prices of goods and services in the two countries, then there will be an arbitrage opportunity, and traders will buy goods in the cheaper country and sell them in the more expensive country, causing the exchange rate to adjust.

For example, suppose that one US dollar can buy two units of a certain good in the United States, while the same good costs three units of a foreign currency in another country. According to PPP, the exchange rate between the two currencies should adjust so that one US dollar can buy three units of the foreign currency. This would mean that the price of the good in the ____ ______ _________ __ _____________ ___ ___________ __________ _____________ ________ __ ________.
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Degree : MASTER DEGREE PROGRAMMES
Course Name : Master in Business Administration
Course Code : MBA
Subject Name : International Financial Management
Subject Code : MMPF 5
Year : 2023