Purchasing Power Parity in the World
Chapter 17 – Purchasing Power Parity
A paper submitted to Webber International University in partial fulfillment of the requirements for the bachelors of Science degree in Finance.
By: Fabricio dos Santos, Ruta Skinulyte and Leticia Tomb
Date: 12/5/2011
FIN 400-1
Professor: Ms. Eberle
Introduction
Purchasing power parity is an economic technique used when attempting to determine the relative values of two currencies. It is helpful because many times the amount of goods a currency can buy in two nations varies drastically depending upon the availability of products, the demand for goods, and a host of others, it is difficult to determine the factors.
Sometimes referred to as the law of one price, PPP implies that the levels of exchange rates and prices adjust so as to cause identical goods to cost the same amount in different countries. For instance, if a pair of tennis shoes costs R$ 150.00 in Brazil and US 100.00 in the United States, then PPP implies that the exchange rate must be R$1.50 per U.S dollar. Consumers could purchase the shoes in the U.S for U$ 100.00, or they could exchange their U$ 100.00 for R$ 150.00 and then purchase the same shoes in the United States at the same effective cost (assuming no transaction or transportation costs).
“The question of how exchange rates adjust is central to exchange rate policy, since countries with fixed exchange rates need to know what the equilibrium exchange rate is likely to be and countries with variable exchange rates would like to know what level and variation in real and nominal exchange rates they should expect. In broader terms, the question of whether exchange rates adjust toward a level established by purchasing power parity helps to determine the extent to which the international macroeconomic system is self-equilibrating” (Alan Taylor, 2004)
PPP Measurement
Purchasing power parity (PPP) implies that the same product will sell for the same price in every country after adjusting for
A paper submitted to Webber International University in partial fulfillment of the requirements for the bachelors of Science degree in Finance.
By: Fabricio dos Santos, Ruta Skinulyte and Leticia Tomb
Date: 12/5/2011
FIN 400-1
Professor: Ms. Eberle
Introduction
Purchasing power parity is an economic technique used when attempting to determine the relative values of two currencies. It is helpful because many times the amount of goods a currency can buy in two nations varies drastically depending upon the availability of products, the demand for goods, and a host of others, it is difficult to determine the factors.
Sometimes referred to as the law of one price, PPP implies that the levels of exchange rates and prices adjust so as to cause identical goods to cost the same amount in different countries. For instance, if a pair of tennis shoes costs R$ 150.00 in Brazil and US 100.00 in the United States, then PPP implies that the exchange rate must be R$1.50 per U.S dollar. Consumers could purchase the shoes in the U.S for U$ 100.00, or they could exchange their U$ 100.00 for R$ 150.00 and then purchase the same shoes in the United States at the same effective cost (assuming no transaction or transportation costs).
“The question of how exchange rates adjust is central to exchange rate policy, since countries with fixed exchange rates need to know what the equilibrium exchange rate is likely to be and countries with variable exchange rates would like to know what level and variation in real and nominal exchange rates they should expect. In broader terms, the question of whether exchange rates adjust toward a level established by purchasing power parity helps to determine the extent to which the international macroeconomic system is self-equilibrating” (Alan Taylor, 2004)
PPP Measurement
Purchasing power parity (PPP) implies that the same product will sell for the same price in every country after adjusting for