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ATIF FINAL PPTppp - EFFECTS OF INFLATION AND EXCHANGE RATE...

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EFFECTS OF INFLATION AND  EXCHANGE RATE ON  PURCHASING POWER PARITY FINAL YEAR PROJECT PRESENTER :MUHAMMAD ATIF KHAN REG #.52387 SUPERVISOR: AAMIR FIROZ SHAMSI
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INTRODUCTION The basis for PPP is the “law of one price” A theory which states that the exchange rate between one currency and another is in equilibrium when their domestic purchasing powers at that rate of exchange are equivalent. One of the key problems is that people in different countries consume very different sets of goods and services, making it difficult to compare the purchasing power parity between countries.
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Law of One Price The law of one price simply says that the same good in different competitive markets must sell for the same price, when transportation costs and barriers between markets are not important. Why? Suppose the price of Big-Mac at one restaurant is $20, while the price of the same Big-Mac at a similar restaurant across the street is $40. What do you predict to happen? Many people would buy the $20 Big-Mac, few would buy the $40.
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Law of One Price (cont.) Consider a pizza restaurant in Karachi and one in Islamabad. The law of one price says that the price of the same pizza (using a common currency to measure the price) in the two cities must be the same if barriers between competitive markets and transportation costs are not important:
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