24 Implications of purchasing power parity 25 If the purchasing power of the

24 implications of purchasing power parity 25 if the

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Implications of purchasing-power parity 25 If the purchasing power of the dollar is always the same at home and abroad, then the exchange rate cannot change. The nominal exchange rate between the currencies of two countries must reflect the different price levels in those countries. High inflation – weaker currency Low inflation – stronger currency
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Implications of purchasing-power parity 26 e = P*/P Big Mac index where e is the nominal exchange rate, P* is the foreign price level and P is the domestic price level. e = US $1,200 S $1,600 US $1 = SG $1.33 OR S $1 = US $ 0.75
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Implications of purchasing-power parity When the central bank prints large quantities of money, the money loses value both in terms of the goods and services it can buy and in terms of the amount of other currencies it can buy. 27
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The German hyperinflation 28
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Limitations of purchasing-power parity Many goods are not easily traded or shipped from one country to another; for example, real estate and many services. Tradeable goods are not always perfect substitutes when they are produced in different countries. PPP theory ignore transport cost 29
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SUMMARY Net exports are the value of domestic goods and services sold abroad minus the value of foreign goods and services sold domestically. Net foreign investment is the acquisition of foreign assets by domestic residents minus the acquisition of domestic assets by foreigners. An economy’s net foreign investment always equals its net exports. 30
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SUMMARY 31 An economy’s saving can be used to either finance investment at home or to buy assets abroad. The nominal exchange rate is the relative price of the currency of two countries. The real exchange rate is the relative price of the goods and services of two countries.
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SUMMARY According to the theory of purchasing-power parity, a unit of currency should buy the same quantity of goods in all countries. The nominal exchange rate between the currencies of two countries should reflect the price levels in those countries. 32
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