跨国金融-12esolutionmanualdocs_12e_im_c07电子教案.pdfVIP

Chapter 7 International Parity Conditions Questions 7-1. Purchasing Power Parity. Define the following terms: a. The law of one price. The law of one prices states that producers ’ of identical quality should be the same in different markets, i.e., different countries (assuming no restrictions on the sale and allowing for transportation costs). If a country has higher inflation than other countries, its currency should devalue or depreciate so that the real price remains the same as in all countries. Application of this law results in the theory of purchasing power parity (PPP). b. Absolute purchasing power parity. If the law of one price were true for all goods and services, the purchasing power parity (PPP) exchange rate could be found from any individual set of prices. By comparing the prices of identical products denominated in different currencies, one could determine the “real ” or PPP exchange rate that should exist if markets were efficient. This is the absolute version of the theory of purchasing power parity. Absolute PPP states that the spot exchange rate is determined by the relative prices of similar baskets of goods. c. Relative purchasing power parity. If the assumptions of the absolute version of PPP theory are relaxed a bit more, we observe what is termed relative purchasing power parity . This more general idea is that PPP is not particularly helpful in determining what the spot rate is today, but that the relative change in prices between two countries over a period of time determines the change in the exchange rate over that period. More specifically, if the spot exchange rate between two countries starts in equilibrium, any change in the different