What does Purchasing Power Parity (PPP) theory suggest?

Purchasing Power Parity (PPP) theory suggests that in the long run, price levels for identical goods should equalize across different countries when expressed in a common currency. This means that if a particular good costs a certain amount in one country, it should cost approximately the same amount in another country when adjusted for the exchange rate. The theory is based on the idea that in an efficient market, with no transportation costs and no differential taxes applied, consumers will act to purchase goods in the country where they are cheaper, thus leading to an equalization of prices.

This concept underpins the rationale behind measuring and comparing the economic productivity and standards of living between nations. If there are significant price differences for the same goods across countries, it indicates that exchange rates are out of balance relative to what PPP would predict, creating opportunities for arbitrage.

The other options, while related to concepts within economics, do not accurately capture the central idea of the PPP theory. The stabilization of exchange rates over time isn't a direct implication of PPP, and while supply and demand influence currency values, they are not the sole determinants according to PPP. Consumer habits do affect exchange rates, but this connection is not the fundamental principle of PPP.