Econ F.7 [Purchasing power pority]?

The PPP theory states that all countries prices are equal when measured in terms of the same currency.

Eg.
US$1 = Yen100
Price of a Big Mac in the USA = US$2
Price of a Big Mac in Japan = Yen200
Price of a Big Mac in Japan = US$2

If the prices are not equal, there will be an arbitrage. That means BUY LOW AND SELL HIGH in the relevant economies.

The PPP theory also states that the exchange rate between any countries currencies adjust to reflect differences in the price levels (or inflation rate) in the 2 countries.

Eg.
If the inflation rate in Japan is 5% higher than that in the USA, the Japanese yen will depreciates by 5%.

But you should know that the PPP may be failure when :
1. absence of free trade
2. presence of non-tradable product
3. presence of different price indices (ie different basket of goods for price indices)
4. presence of transaction costs
5. other factors (government tax or subsidies, different profit margin set by firms, etc)

Purchasing power parity (PPP) is the method of using the long-run equilibrium exchange rate of two currencies to equalize the currencies' purchasing power. It is based on the law of one price, the idea that, in an efficient market, identical goods must have only one price.