ECN 211 L17 PPP and IRP_BB

# ECN 211 L17 PPP and IRP_BB - ECN 211 Macroeconomic...

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ECN 211 Macroeconomic Principles L17: Theories of Exchange Rates

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Recap: Exchange rates ……..The price of one currency in terms of another. Example: €1 sells for 1.4\$ Define: “E” is the number of domestic units (dollars ) required to purchase one unit of a foreign currency (Euro). In the example above E is ____
Recap: Appreciation and Depreciation . If the exchange rate last year was \$2.0:€1. But this year the exchange rate was 1.5\$ = 1 E What has happened to the dollar over the year? The dollar has appreciated against the euro. “E” decreased from 2 to 1.5 Of course this must mean the euro has depreciated against the dollar!! Remember changing exchange rates affect the domestic price of foreign goods.

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Recap: Price of goods and services. Domestic price of a foreign good =foreign currency price * exchange rate Q) Suppose the exchange rate is \$1.50: €1. If a bottle of French wine is 25 euros what is the dollar price for the wine? A) dollar price =25* 1.50 = 37.50 So far we have simply converted the price of a foreign good into its dollar amount. Dollar appreciates: Imports increase and Exports decrease
What about if the good was the same in both  countries? If a US citizen finds that goods sell for the same price   in  the US and UK (when converted into a common currency)  then we have  PPP Purchasing power parity:

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