Ppp Case Study

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Generally, there are two common methods that we can use to check if the PPP holds: the unit root test and cointegration test. The first method is the unit root tests which is to check the stationary or non-stationary of the real exchange rate. If it is stationary, it means the PPP will hold; if it is non-stationary, the PPP does not hold. Another method is cointegration test that can be used to test the residuals, this method can help to avoid wrong regression results. (Charles Engel (1998) & Douglas G. Steigerwald (1996)) The problems with PPP: As many economists concluded, the PPP cannot hold in practice due to there are five main problems behind PPP. In this part, I will explain each one of them in detail. Frist problem is statistical.…show more content…
M. Suranovic, 1999). Since the Law of on price concept is underlying the PPP, both of the theories have the same assumptions. In the previous part, I mentioned the assumptions underlying the law of one price is assume there is no transportation costs and other barriers to trade between the markets which can be implied as there are no trade restrictions in those markets. Despite that, those types of costs and trade restrictions exist in real world, as the transport cost increase, the movement of the exchange rate can be greater and the price of any identical goods can be more expensive. For example, there is a graph from Mohammed and Jeffrey‘s (2004) paper shows the deflated by Jute price are fell faster than the index deflated by Sauerbeck. This means the long distance transport costs fell sharply during the 19th century, and the reason could be the difference between the different routes become less and as well as the price of…show more content…
According to PPP or Law of on prices, if convert the price of a basket of goods in one currency into another currency, the price should be same. But in the real world, when an identical basket of traded and non-traded goods are converted to a common currency, the price index tend to be higher in richer countries. For instance, one dollar can buy more goods in Mexico than in the US. Because of this problem, a modification model is introduced by Balassa (1964) and Samuelson (1964) which are aims to amend the PPP. The Balassa Samuelson model indicates that due to the lower productivity of traded goods sector in developing countries, the price of non-traded goods is lower. That is, the low productivity in tradable sector lead to cheap labors which means the price in non- tradable sector are low. In addition, the Balassa Samuelson effect suggested that the higher income for each capital, the higher the relative price of non-traded goods. As Kenneth (1996) mentioned in his paper, the relationship between the country income and prices is
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