Compare and contrast the absolute and relative versions of the principle of purchasing power parity (PPP) and evaluate the principle’s practical usefulness.
Definition of Purchasing power parity
PPP is an economic theory that states that the price of common goods between two different countries compared should be equal when converted in to a common currency.
PPP ratio presents two countries identical products or group of products relative price level difference. The basis for PPP is “law of one price”
The law of one price simply states that, in the presence of a competitive market structure and the absence of transport cost and other barriers to trade, identical products which are sold in different markets will sell at the same price when expressed in terms of a common currency (Keith Pilbeam fourth edition, p.126).
The law is mathematically expressed as follow:
PAFN = E x PRs
In above formula PAFN is the price of product in Afghani, PRS is the price of product in Pakistani Rupees and E is the exchange rate between Afghani and Pakistani Rupees.
For example, if price of an identical TV in Afghanistan is 1000 AFN and it cost 2000 Rupees in Pakistan then according to law of price the exchange rate should be 0.5 and if the exchange rate were higher which is 0.6 then Pakistani trader will start buying the TV from Afghanistan and trade it to Pakistan since an arbitrage profit opportunity arises and the traders will continue to trade for profit by selling Pakistani Rupees and Purchasing Afghani which arises an increase in demand for Afghani and leads to depreciation of Pakistan Rupees, this will continue until the point the arbitrage profit opportunities are eliminated, the market forces demand and supply took hold and price c...
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...omic event that are sudden and causes a relative change in price level.
Studies found that relative PPP holds better in long run than in short run
In General studies persist that PPP is not theory of exchange rate since exchange rate is variable to other factors than price. Price and exchange rate are endogenous variable.
Purchasing Power Parity used under three concepts to explain identical goods should cost the same in two different countries when converted in common currency. The law of one price relates exchange rate to price of individual goods. The absolute PPP relates exchange rate to general price level and relative PPP relates exchange rate to inflation rate.
Reference
Author’s SURNAME, INITIALS., Year of publication. Title. Edition (if not the first). Place of publication: Publisher.
Reference to web pages /sites and e-books/ e-journals
The purchasing power parity implies the following relationship between the home (GB £) and local (US $) costs of debt:
...lict. Neighboring countries will want to maximize their own revenues and in order to do so, they will set their own prices for goods and services.
The Mc Donald Big Mac index, also known as the Big Mac Purchasing Power Parity (PPP) is a periodic survey done by “The Economist” magazine. This index measures the Purchasing Power Parity between nations using the international prices of the burger as a benchmark (R.L.W., 2014). The index draws its rationality from the concept of “the law if one price”, which infers that in the long-run, all goods must sell for the same price in all locations. This law constitutes the bases of the Purchasing Power Parity theory, which is derived from no arbitrage postulation.
The real exchange rate tells us the rate at which we can trade the goods of one country for goods from other countries. The real exchange rate some- times referred to as the terms of trade. To view the exchange rate relationship in real terms using the nominal exchange rate, can be taken samples h a goods produced in some countries, such as cars. Suppose the price of the car with 25,000 dollars, while the price of Japanese cars is 4,000,000 yen . To compare the prices of both cars , we have to transform them into a common currency. If one dollar worth of 80 yen , the price of cars Americans to 80 x 25,000, or 2,000,000 yen. By comparing the price of an American car (2,000,000 yen) and the price of Japanese cars (4,000,000 yen), it can be concluded that the price of the American car is half the price of Japanese cars . In other words, pad a price effect we can swap two American cars to get a Japanese car . Peng count can be written as
To calculate the change in his purchasing power (CPP) we can use the following formula:
Historically, this is outlined in the domestic societal framework (a rationalist point of view dictating political outcomes as a direct result of domestic material interests in society). Whatever society wants, society gets, leaving the consumer is to benefit from a fixed exchange rate. Competition exists between all interests. Whatever interest dominates takes the winning interest. The winning interest, then, determines the outcome. With businesses facing pressure to decrease domestic prices, consumers now have the upper hand. (Wellhausen, 10-2-14). Thus, due to the enhancing credibility of the government, consumers also are to benefit from a fixed exchange rate. (Multiple governments
It is common to classify the exchange rate into two types, nominal exchange rate and real exchange rate. Nominal rate of exchange defined as the value of the domestic currency in relation to a foreign currency without consideration of the inflation rate (Piana, 2001). Similarly, as Basak and Gallmeyer (1998) maintained that nominal exchange rate is expressed as number of units of home currency that can purchase a unit of another currency. For example, if the nominal exchange rate between the GBP and the USD is 1.55, then one pound will purchase 1.55 dollar. By contrast, real exchange rate takes inflation into consideration, which reveals how much the goods and services in the ho...
One principle of fair trade is the agreed minimum price that is set above the market price. Each fair-trade
Topic A (oligopoly) - "The ' An oligopoly is defined as "a market structure in which only a few sellers offer similar or identical products" (Gans, King and Mankiw 1999, pp.-334). Since there are only a few sellers, the actions of any one firm in an oligopolistic market can have a large impact on the profits of all the other firms. Due to this, all the firms in an oligopolistic market are interdependent on one another. This relationship between the few sellers is what differentiates oligopolies from perfect competition and monopolies.
For our paper, we obtained the Big Mac PPP exchange rate between the US Dollar and the Canadian Dollar, Japanese Yen, Pound Sterling and the Singapore Dollar. We first wanted to know what the exchange rate should be by taking the (current Exchange Rate)*(US Dollars per Burger / Local Currency per Burger). We then wanted to find out if the currency is over or under-valued according to our figures. We obtained this information by (Exchange Rate minus should be rate)/ (Should Be value from previous equation). If this percentage is positive then we believe the currency is over-valued. If this currency is negative then we believe the currency to be under-valued.
This is an exchange rate system where the currency exchange rate system is allowed to be determined by the forces of demand and supply. Here, the central bank and the government do intervene to cub extreme exchange rate fluctuation by adopting monetary or fiscal policy.
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?
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.
Products requiring similar resources (bread and pastry, for instance) will have an almost straight PPF and so almost constant opportunity costs. More specifically, with constant returns to scale, there are two opportunities for a linear PPF: if there was only one factor of production to consider or if the factor intensity ratios in the two sectors were constant at all points on the production-possibilities curve. With varying returns to scale, however, it may not be entirely linear in either