Ch11(2) - The law of one price(LOOP states that the price of the good in each market must be the same This is a microeconomic concept applied to a

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The law of one price (LOOP) states that the price of the good in each market must be the same. This is a microeconomic concept, applied to a single good, g. Relative price ratio for g : If LOOP holds then (for each good g): This means the price of good g is the same in Europe and in the U.S. What if LOOP doesn’t hold? Goods more expensive in Europe than in the US Goods less expensive in Europe than in the US Macroeconomic counterpart to LOOP. If LOOP holds for every good in CPI basket, then the prices of the entire baskets must be the same in each locations. The purchasing power parity (PPP) theory states that these overall price levels in each market must be the same. Relative price level ratio: PPP ( Absolute PPP ) is said to hold when, for the basket price levels P: This implies that a basket of goods purchased in two countries should cost the same in a common currency. The absolute PPP also implies that the exchange rate at which two currencies
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This note was uploaded on 03/02/2012 for the course EC 340 taught by Professor Ballie during the Spring '10 term at Michigan State University.

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