A version of purchasing power parity (PPP) that predicts the exchange rate to adjust so that the internal purchasing power and the external purchasing power of a currency are equalized. The internal purchasing power is the reciprocal of the price level, whereas the external purchasing power is a combination of an exchange rate and a foreign currency-denominated price level. Equating both types of purchasing power will produce the absolute purchasing power parity exchange rate:
And
Of course, the local price level means the price level denominated in local currency (say dollar), whilst the foreign price level implies the price level denominated in foreign currency (say euro). The parity exchange rate is the price of local currency in terms of foreign currency (€/$). The absolute PPP predicts what the exchange rate should be in view of the price levels in two countries.
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