Chapter_16_-_Purchasing_Power_Parity

Chapter_16_-_Purchasing_Power_Parity - Chapter 16 Price...

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Purchasing Power Parity (PPP) Purchasing power parity: the idea that exchange rates are determined by the amount of different currencies required to purchase a representative bundle of goods. In other words, it is the concept that explains movements in the exchange rate between two currencies by changes in the countries’ price levels. When PPP holds, an individual will be indifferent in buying an identical good at home or abroad because it will cost the same amount of money in different countries when measured in the same currency. Absolute Purchasing Power Parity (APPP) It is the form of PPP stated in terms of levels of prices and level of exchange rate . More formally, APPP tells us that in the absence of frictions such as transportation costs, tariffs and others, it should cost the same amount of money to purchase an identical basket of goods in different countries when expressed in the same currency In notation form, APPP can be expressed as: Let: P = # of DC per basket of goods at home P* = # of FC per basket goods abroad PPP implies: P = E DC/FC × P* Relative Purchasing Power Parity (RPPP) It is the form of PPP stated in terms of inflation rates and changes in exchange rates. RPPP tells that percentage change in the exchange rate between two currencies over any period equals to the inflation rate differentials between the two countries. In notation form, RPPP can be expressed as:
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This note was uploaded on 12/21/2011 for the course ECONOMICS ECMC61 taught by Professor Dr.irisau during the Fall '11 term at University of Toronto.

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Chapter_16_-_Purchasing_Power_Parity - Chapter 16 Price...

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