Purchasing Power Parity
Purchasing Power Parity, and How it Determines the Value of the Dollar
Course: BBUS 452, International Trade Finance
Professor: Giuseppe Liberatore
Group Members:
Pamella De Lima Ishy
Carlos Guerrero
Ricardo Iraheta Reyes
Ann-Marie Mlinac
Literature Review
“Is Purchasing Power Parity a Useful Guide to the dollar?” This article was our starting article which gave us the idea of researching the Purchasing Power Parity. It identifies that the Purchasing Power Parity should work in the long run, and that the exchange rates should move towards rates that would balance the prices of an identical basket of goods and services between two countries.
There are two types of Purchasing Power Parity, which are absolute and relative. The absolute Purchasing Power Parity is the “law of one price (Hakkio, 1992). If there are no transaction/transportation costs or trade barriers, identical goods sold in different countries have same price when expressed in a common currency. There are two main assumptions related to absolute Purchasing Power Parity. The first is that arbitrage eliminates price differences and the second is that the prices of goods are relatively identical between countries.
In contrast, the relative Purchasing Power Parity is the idea that goods and services do not have the same prices across different countries (i.e Canada and the U.S) and even in common currencies (i.e. the Euro). The absolute Purchasing Power Parity implies relative Purchasing Power Parity, however it does not work the other way.
The Purchasing Power Parity relies greatly on the “law of one price (Hakkio, 1992). The Purchasing Power Parity is hard to predict in the short term since there are always fluctuations in prices. An example of the Purchasing Power Parity would be that if the “domestic price level increases by 10%, the domestic currency should decrease by 10% (Hakkio, 1992).
There is no question that in every theory there are some limitations that
Course: BBUS 452, International Trade Finance
Professor: Giuseppe Liberatore
Group Members:
Pamella De Lima Ishy
Carlos Guerrero
Ricardo Iraheta Reyes
Ann-Marie Mlinac
Literature Review
“Is Purchasing Power Parity a Useful Guide to the dollar?” This article was our starting article which gave us the idea of researching the Purchasing Power Parity. It identifies that the Purchasing Power Parity should work in the long run, and that the exchange rates should move towards rates that would balance the prices of an identical basket of goods and services between two countries.
There are two types of Purchasing Power Parity, which are absolute and relative. The absolute Purchasing Power Parity is the “law of one price (Hakkio, 1992). If there are no transaction/transportation costs or trade barriers, identical goods sold in different countries have same price when expressed in a common currency. There are two main assumptions related to absolute Purchasing Power Parity. The first is that arbitrage eliminates price differences and the second is that the prices of goods are relatively identical between countries.
In contrast, the relative Purchasing Power Parity is the idea that goods and services do not have the same prices across different countries (i.e Canada and the U.S) and even in common currencies (i.e. the Euro). The absolute Purchasing Power Parity implies relative Purchasing Power Parity, however it does not work the other way.
The Purchasing Power Parity relies greatly on the “law of one price (Hakkio, 1992). The Purchasing Power Parity is hard to predict in the short term since there are always fluctuations in prices. An example of the Purchasing Power Parity would be that if the “domestic price level increases by 10%, the domestic currency should decrease by 10% (Hakkio, 1992).
There is no question that in every theory there are some limitations that
References: TD Bank Financial Group. (2008, 01 30). Retrieved from TD Economics Special Report: http://td.com/economics/special/mm0108.candol.pdf Hakkio, C. S. (1992, 09). Is Purchasing Power Parity a Useful Guide to the Dollar. Retrieved from http://www.frbkc.org/PUBLICAT/EconRev/EconRevArchive/1992/3Q92hakk.pdf Kocaeli, S., & Durmus, C. (2004). The Validity of Purchasing Power Parity. Retrieved from http://smye2009.org/file-002_KOC.pdf Ramirez, M, & Khan, Shahryar. (1999). A cointegration analysis of purchasing power parity: 1973-96 . Manuscript submitted for publication, Retrieved from http://www.iaes.org/journal/iaer/aug_99/ramirez/