@Ju1882 3 August 2020 edited more from that month

Purchasing Power Parity Theory - Foreign Exchange

****Purchasing Power Parity Theory**** Foreign exchange rates are dependent on inflation. Higher the inflation rate in one country as compared to the other country results in discount of currency of that country and vice-versa. ****Example**** On 01/01/2020 1 Euro = 1.4000 $ And 1 Kg. of goods ' X ' can be purchased in USA for 1.0000 $ Europe for 0.8772 Euro. It means 1 Kg. of goods ' X ' can be me purchased by 1.0000 $ in either USA or in Europe. Or 1 Kg. of goods ' X ' can be purchased by 0.8772 Euro in either USA or in Europe. Suppose, Inflation rate in Europe is 2% and 3% in USA. After one year ( on 31/12/2020 ) 1 Kg. of goods can be purchased by In USA 1.0000 X 1.03 = 1.0300 $ In Europe 0.8772 X 1.02 = 0.8947 Euro According to Purchasing Power Parity Theory, purchasing power should be same in both countries. Therefore, Price of 1 Kg. of goods ' X ' = 1.0300 $ = 0.8947 Euro => 1.0300 $ = 0.8947 Euro => 1.000 Euro = 1.1512 $ In the given example inflation rate in USA is higher than Europe.Therefore '$' depreciate against ' Euro. Thank you for reading.