Final answer:
A country's currency is overvalued in terms of purchasing power parity (PPP) when it strengthens more than what the inflation differential would justify. The PPP theory expects currencies to adjust to equalize the prices of internationally traded goods when expressed in a common currency, but overvaluation can occur if the currency does not depreciate as inflation rises.
Step-by-step explanation:
When a country's currency strengthens relative to another country's currency by more than what is justified by the differential in inflation, it is said to be overvalued according to the concept of purchasing power parity (PPP). The PPP is a theory which states that in the long term, exchange rates should adjust to equalize the price of internationally tradable goods across different countries when priced in a common currency. In the case where inflation is higher in one country compared to another, the higher-inflation country's currency should theoretically depreciate to maintain PPP.
However, if the currency does not depreciate accordingly, or appreciates instead, it leads to an overvaluation relative to the PPP exchange rate. An example of this can be seen with the Mexican peso in the 1980s, as Mexico experienced a high inflation rate, which typically should have led to a depreciation of the peso. Instead, if the peso value increased, it would be considered overvalued, discouraging demand for the currency and potentially leading to negative economic implications.