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post 1
According to (Hill-Hult. 2021) PPP is an adjustment in gross domestic product per capita to reflect differences in the cost of living. Under the PPP Theory, the United States dollar will be inflated to match other markets. This in theory will make the trade more equal. A U.S. dollar value must be assigned to everything. That includes items not widely available in America. For example, there aren’t too many ox carts in the United States. Also, it is doubtful that the cart’s U.S. price would accurately describe its value in rural Vietnam, where it’s needed to grow rice. Using PPP exchange rates in addition to a country’s gross domestic product (GDP) may help to provide a more detailed picture of a country’s economic health. The theoretical value is also helpful to traders in foreign currency and investors holding foreign stocks or bonds as it helps to predict fluctuations in international currency and indicate weakness.
post 2
According to Hill & Hult (2019), “a government increasing the money supply is analogous to giving people more money.” This would eventually lead to inflation. According to the PPP theory, in this scenario, the U.S. dollar would see depreciation in its currency exchange rate. The depreciation in the currency would help the country re-achieve Purchasing Power Parity (PPP). Once PPP is achieved and is equal with other countries, exchange rates will be in equilibrium once again. Overall, this helps us achieve the law of one price that was presented in the readings. According to Hill & Hult (2019), the law of one price states that in competitive markets “free of transportation costs and barriers to trade (such as tariffs), identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency.” This is exactly what achieving equal PPP across different countries can help us achieve.
Hill & Hult (2019) explain that Purchasing Power Parity (PPP) “links changes in the exchange rate between two countries’ currencies to changes in the countries’ price levels.” Inefficient markets, we can find the PPP exchange rate by looking at the prices of identical products in different currencies. The readings even present us with the concept of the ‘Big Mac Index.’ According to The Economist (2021), the Big Mac Index was a term invented in 1986 “as a lighthearted guide to whether currencies are at their “correct” level.” Surprisingly, it quickly became a global standard. By looking at the price of the McDonalds Big Mac across different countries, the Big Mac Index helps measure and compare the Purchasing Power Parity between them.
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