 Purchasing power parity refers to an idea that the exchange rate adjusts itself in order to keep the purchasing power constant among different currencies. There are two forms of purchasing power parity. First form is known as absolute purchasing power parity whereas the second form is known as relative purchasing power parity. So far as the absolute purchasing power parity is concerned, the basic idea behind this phenomena says that a commodity does cost the same irrespective of the currency used to buy it and the place where it is selling. For example, $1 will help you buy same number of same commodity anywhere in the world and this is due to the application of law of one price. Now to understand this concept let take an example. We have an example of beer that cost in London at 2 pound per unit whereas the exchange rate per dollar is equal to 0.60 pound. Using this data if we determine the price of a beer in New York then it comes to the value of 3.33 pound per unit of beer in New York. Now for as the absolute purchasing power parity is concerned in this case let we assume S0 being the spot exchange rate between UK pound and the US dollar and PUS and PUK are the prices of apples in UK and US respectively. An absolute purchasing power parity says that the price of any commodity in UK is equal to the price of same commodity in US multiplied by the spot exchange rate. The rationale behind the absolute purchasing power parity is similar to the rationale behind the triangular arbitrage and that says that purchasing power parity if it does not hold then there exist some opportunities for arbitrage. Now let have an example to understand how this arbitrage opportunity will work. Apples in New York are selling at 4 dollars per bushel whereas apples in London are selling at 2.40 pound per bushel and absolute purchasing power parity implies as we have seen that the price in UK is equal to the price in US multiplied by the spot exchange rate. Now using the data of values we have and if we put the figure in our this equation we see that we are missing the value of spot exchange rate and rearranging the equation we come to the spot exchange rate that is 0.60 pound per dollar. This means that this is the implied spot exchange rate of UK pound and US dollar and that is 0.60 pound per US dollar. So the pounds equal worth is then equal to 1.67 US dollar. Now let assume that the actual exchange rate is 0.5 US pound per US dollar then we have to work in different steps in order to materialize the arbitrage opportunity. At the first step we need to buy apple at 4 dollars per bushel in New York and sell these bought apples in London at 2.40 pound per bushel. We see that then we need to convert these 2.40 pounds in to the dollars at the exchange rate of 0.50 pound per US dollar. This will yield a total of 4.80 US dollars. So our investment in this activity starts from 4 dollars and it is ending with 4.80 dollars and this 4 step arbitrage process has resulted in a round trip profit of 0.80 cents. Now what are the implications of this potential profit? This profit potential allows movement either in exchange rates or in the apple prices or in the both. Let's see apples will begin moving from New York to London and due to this there will be reduction in the supply in the New York and this would give a rise to the price of apples in London and as a case the increased supply in London would lower the prices of apples in London. On the other hand the apples trader would convert pounds back into dollars to buy more apples and as a result there will be increase in the supply of pounds and simultaneously the increase in the demand for the dollars as well. So what will happen in the last? In fact the value of the pound will be starting falling. Because the dollar would be getting more valuable as a result we can say that it would take more pounds to buy one unit of dollar. Now to have an absolute purchasing power parity to hold true there must be some prerequisite like the transaction cost must be zero there must not be any barrier to the entry for the trade and the product to trade must be the identical and if any of the above conditions are violated then it is not surprising that absolute purchasing power parity will really applicable to the trade goods or the uniform goods in fact.