5 International Finance II

5 International Finance II - Purchasing Power Parity...

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Purchasing Power Parity Principle: Goods Can’t Have Different Prices In Different Countries The Adjustment Mechanism Foreign Goods Become Cheaper Increase Demand For Foreign Goods Increase in Demand Form Foreign Currency Value Of Foreign Currency Increase Prices Are Equalized KEY Lower Inflation Abroad Rise in Value of Foreign
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Two Types of PPP Absolute Purchasing Power Parity -- Compares Prices at a Point in Time -- Looks at Prices of Individual Products Relative Purchasing Power Parity -- Predicts Changes in Prices over Time -- Looks at Overall Price Levels (Inflation that is Expected)
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Absolute Purchasing Power Parity (PPP) AT ANY POINT IN TIME, ANY GOOD  (OR A BASKET OF GOODS) SHOULD COST THE SAME  IN ANY TWO COUNTRIES --  IF NOT, MOVE GOODS AND MAKE PROFITS --  FINAL PRICES BECOME EQUAL FOR THE GOOD What Value of the Yen Will Make the Prices Equal? ______ Yen X (?) $/Yen = $ . ______ (Big Mac in Yen) (Big Mac in $) Do You Have Enough to Buy a Big Mac in the Other Country? Yes: Foreign Currency of OVERRvalued;
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5 International Finance II - Purchasing Power Parity...

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