Premium Essay

Purchase Power Parity

In: Business and Management

Submitted By delta616
Words 910
Pages 4
Purchasing Power Parity
I. Introduction In every transaction we have two parties, one who is receiving a product or service, and one who is expecting a predetermined amount of money for the product. The purchaser expects to pay the same dollar amount whether they are at home using their currency or abroad exchanging their home currency for the foreign currency. In a perfect world this would prove the Purchase Power Parity that we will discuss in this paper. There is great history of the evolution of the currency, and how the price of that currency has affected price. These changes will be explored to see if there are any correlations that we can show. In this paper we will attempt to test the correlation between the increase and decrease in price against the increase and decrease of the value of the currency for a specific country. II. Purchase Power Parity
Purchase Power Parity can be defined as the law of one price where the identical product would sell for the same price no matter the location. The PPP is applying that law of one price to currency. Purchase Power Parity is an economic theory that estimates the amount of adjustment needed on the exchange rate between countries in order for the exchange to be equivalent to each currency's purchasing power. In other words, the exchange rate adjusts so that an identical good in two different countries has the same price when expressed in the same currency. Gustav Cassel developed this theory, in its current form, in 1918. The PPP only works when you can price on goods where the product is the same no matter the location of the transaction. Tariffs and taxes can also affect the price, so depending on the laws of that specific country this can also have an effect on if PPP would work.
The question we will attempt to answer is if there is a correlation between the rate of price inflation and…...

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