Internal and External Purchasing Powers
Having understood the price level concept and its relationship with price index we can then look into the two different purchasing power principles: internal and external.
Internal purchasing power of a particular currency is a reflection of the value of how much a consumer can buy with the given amount of domestic currency in the particular country. In other words, that is the amount of goods and services that can be purchased with a pound in the United Kingdom, or alternatively a dollar in the United States. Over time the value of money is constantly decreasing and a pound 10 years ago could buy considerably more than a pound today. The CPI table is a perfect example that illustrates this process in real life: in 2013 consumer would have to spend £107.7 for goods that in 2010 could be bought for £100. Usually internal purchasing power level is measured in consumption bundles. That is how many of these consumption bundles can be bought for particular amount of domestic currency in home economy. For example if a consumption bundle of particular fixed goods and services in the UK costs £20,000 with £100,000 we could buy 5 of these bundles. This raises a question: if we would be able buy the same 5 bundles for £100,000 in the USA or any other country in the world? To answer this question we should analyse the external purchasing power.
External purchasing power of a currency reflects the value of how much a consumer can buy with a particular amount of home currency in a different country. In order to determine the external purchasing power of a pound in the USA, as per our example, we would need to convert the pounds into dollars and then calculate how many consumption bundles we would be ...
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...2.80$ in the USA. As we can see the prices in most of the countries are completely different. With Switzerland being the most expensive country to buy both BigMac (5.11$) and a tall latte at Starbucks (4.54$) and the least expensive country for a BigMac being China (1.23$) and Thailand (1.93$) for the tall latte.
The smaller table shows how strongly the local currency is either undervalued or overvalued against the US dollar. These valuations can be used to predict the appreciation or depreciation of a particular currency. Therefore it could be a reasonable factor to consider for the financial managers. Knowing how a particular currency would move in the future on the foreign exchange markets could prevent the managers from making decisions that might lead to a loss because of the fluctuations of currency in which most of the corporations transactions are settled.
“GDP measures the monetary value of final goods and services—that is, those that are bought by the final user- produced in a country in a given period of time (a quarter or a year). It counts all of the output generated within the borders of a country.” (International Monetary Fund. n.d.)
The nominal exchange rate, the relative price of currencies of two countries. For example, if the exchange rate between the dollar A S and the Japanese yen is 80 yen per dollar . Japanese people who want to have dollars, ak early pay 80 yen for each dollar he bought. While the Americans who want to have the yen will get 80 yen for each dollar he was paid. When people refer to " exchange " between the two countries,
Strong is good. Weak is bad. These generalizations sound simple enough, but they can be very confusing when come to money. Is a "strong" U.S. dollar always good? Is a "weak" dollar always bad? Understanding of it is a necessary in marketplace. The term such as “Strong” and “weak” dollar is a “hot topic” which always bandied about by economist on a daily basis and also public. This issue is so important to almost every one. It seems like part and parcel of people who very concern about currency likes investors, economist, foreigners who study or working in the United State and so on.
...such methods have led not only to intervallic spikes of high inflation, disastrous devaluations and financial troubles, but also to enduringly elevated nominal and real interest rates. The possibility of devaluation precludes integration into the global financial markets. The power to devalue has not catapulted exports over the longer term. Actually, it is just the opposite. It has seen to locking developing nations into low valued-added products exposed to wide and unpredictable price shifts. The country of El Salvador calculated the pros and cons of having domestic currency through two consecutive administrations and, ultimately, made the choice to dollarize based on their critical examination. Some countries may discover it practical to conduct their own analysis, and others may find it valuable to embrace the monetary services provided by the dollar global economy.
The pricing process is dependent upon factors which can be categorized as internal and external factors. The internal factors include the factors that are within the control of the organization or the producer, whereas the external factors are influenced by the market or factors which are beyond the control of the producer.
PPP problems go into exchange rate policy when a country is seeking to gain advantages by a cautious policy of maybe veering the exchange rate away from PPP. A real depreciation serves to gain competitiveness and shift employment toward the depreciating country.in Europe the unemployment rates our lower because their dollar value on the exchange rate exceeds ours creatign more business which in turn equals mor jobs. During the 1930s people would call this "beggar—thy-neighbor" policy and in World War II it became "export— led growth." A policy of appreciation by difference is to serve and reduces the inflationary pressure as the rate of increased traded goods prices is being shoved way below the rate of inflation. These economic effects of purchasing power disparities, are really not so difficult to bring about such as : easy money in the short term, serves to veer the exchange rate and that creates employment. In contrast though, a economy that may strongly indexed with exchange rate influence’s on an attempt at creating employment equaling easy money would probably be really frustrating as the exchange depreciation trigger off-setting the wage and price of inflation. Deviations from PPP have also been used as a disinflation.
When considering the currency exposure that would need to be managed by Roraima, three aspects must be considered. Transaction exposure, translation exposure and economic exposure. Transaction exposure would be when dealings would be “affected by fluctuations in foreign exchange rate values” (306). Translation exposure would occur when these exchange rate differences show up differently on the financial statements. And lastly, the economic exposure refers to a situation in which the projected “earning power is affected by changes in exchange rates” (307). Economic exposure is the concept that best reflects the overall process of managing foreign exchange risk because it deals with the long-term effects of a global strategy and earning power. The firm would have to be alert to changes in exchange rates enabling them to project their costs and
The stability of currency values plays a significant role for economic and financial stability. It is not difficult to see the exchange rate fluctuations are widely regarded as damaging. As the movements of the exchange rate have significant and large effects on the trade balance, resource allocation, domestic prices, interest rate, national income and other key economic variables. Then can exchange rate movements be predicted by these fundamental economic variables?
In addition, the future exchange rate can lead to decrease Tiffany 's profits because the yen is thought to be overvalued in comparison to the dollar. These risks are fairly serious because the extreme volatility in the exchange rate creates significant uncertainty in what the future exchange rate and profits will be.
The output or GDP of Canada has increased from 1995 to 1999. This means that more people became employed or productivity has risen. With the GDP on the rise, Canada is able to buy more because people will have more money from work. This would appreciate the dollar because Canadians need the U.S. dollar to purchase our goods.
Nominal gross domestic product refers to the value of GDP before accounting for the changes effected by inflation and deflation (Coyle 32). It shows the level of growth or shrinking of a country’s economy but does not put into consideration the consumer buying power. The value can be misleading to a nation because it does not reflect the real growth value of the economy.
Taylor, A. M. & Taylor, M. P., 2004. The Purchasing Power Parity Debate. Journal of Economic Perspectives, 18(4), pp. 135-158.
The foreign exchange market is one of important mechanism in the international business because foreign exchange is an intermediary for all nations in term of the growth of the economy. There are many functions of foreign exchange market in the global economy. In the international business, it uses the foreign exchange markets in four ways. First, the pay...
The first of these exchange rates, nominal, is the number of units of a given currency that can purchase a unit of a given foreign currency (INSERT CITATION). When using this rate, countries are able to value of their own currency relative to one-another when trading in the foreign exchange market. This principle, however, is not exclusive to trading currencies. Similar to the nominal exchange rate, the real exchange rate uses goods and services in place of currency. As a result, it is defined as the amount of goods or services that can be traded in one country for a good or service in another country. Using this rate, countries are able to gauge the competitiveness of their goods and services in trading with any given country, making it a key factor for countries trading in the global economy.
As an aftereffect of inflation, the purchasing power of a unit of money falls. For instance, a pack of gum that costs $1 and if inflation rate is 2% then in a given year will cost $1.02 the following year. As products and services require more cash to buy, the implicit value of that currency falls.