Master the IB International Economics HL 2026 – Elevate Your Knowledge and Ace the Exam!

Purchasing Power Parity (PPP) estimates the amount of adjustment needed between currencies when comparing the relative value of currencies based on the price of a similar basket of goods in different countries. The core concept of PPP is that in the absence of transportation costs and barriers to trade, identical goods should have the same price when expressed in a common currency.

When the prices of goods diverge significantly between countries, it indicates that the current exchange rate may not adequately reflect the true purchasing power of each currency. Thus, PPP provides a framework for understanding how much adjustment is necessary to bring the exchange rates into alignment with each country's price levels. This adjustment helps to account for differences in inflation rates and cost of living across countries, establishing a more stable basis for comparing economic performance.

The other options provided do not directly relate to the main function of PPP. For instance, current account transactions focus on a country's trade balance and does not necessarily involve adjustments in exchange rates. Capital and financial accounts pertain to investment flows and do not address price level differences between countries. Future currency forecasts deal with predictions about future exchange rates rather than aligning them to current purchasing power disparities. Therefore, the focus of PPP on estimating necessary adjustments between currencies makes it the most suitable choice.