Purchasing Power Disparity
Any points off of the PPP line represent purchasing power disparity. If the exchange rate does not move as PPP theory suggests, there is a disparity in the purchasing power of the two countries.
Point C in Exhibit 8.3 represents a situation where home inflation (Ih) exceeds foreign inflation (If ) by 4 percent. Yet, the foreign currency appreciated by only 1 percent in response to this inflation differential. Consequently, purchasing power disparity exists.