Power Purchase Parity Essay Example | Topics and Well Written Essays - 3500 words

Power Purchase Parity - Essay Example The conclusion is that this is highly assumptive and neglects other possibilities that control the relative price and exchange rates. Economists argue that the economic benefits of trade between nations in goods, services, and assets are similar to the benefits of trade within a nation. In both cases, trade in goods and services permits greater specialization and efficiency, whereas trade in assets allows financial investors to earn higher returns while providing funds for worthwhile capital projects. However, there is a primary difference between domestic versus international transactions; specifically, trade within a country normally involves a single currency, but trade between nations usually involves dealing in different currencies. There are also subtle and unavoidable concerns when establishing in purchase power parity that exchange rates are only controlled by relative pricing. This theory requires that stabilisation and equivocal trade are inherently continuous, and does not account for cost, policy and specialisation as substitution. Therefore, while purchase power parity holds in some cases, it can not be assumed (as it currently is) to hold in all cases. It will only hold under specific criterion, and not when there is fluctuations in real cost and trade. To understand the founding principles of purchase power parity, a first l... Exchange rates are the cost of one good compared to the price of another across national borders. The exchange rate simply converts the GDPs (Gross Domestic Products) into the same currency units. Even when valued in the same currency unit, the ratios of GDPs in different countries still have to be split into their volume and price components. This is often believed to be controlled by the theory of relative prices, that one product has an equal value to another product in different countries. The law of one price is the founding principle of this theory, explained by the purchase power parity concept. Purchasing power parities (PPP) are rates of currency conversion constructed to account for cross-country variation in prices. The calculation of PPPs is based on pricing a representative basket of goods and services across countries, and weighing this basket with the expenditure patterns prevailing in each of the countries. The PPP conversion rate allows for volume comparisons, i.e. comparisons involving the level of health expenditures in real terms. Exchange Rate The foreign exchange is the act of trading money between nation, where the money takes the same form of the originating country, and monetary assets traded in foreign exchange markets are demand deposits in banks. The exchange rate is specifically the price of one country's money in terms of another country's money, and this is very dependent on the time-value of money (Hallword and McDonald 2000). Foreign exchange quotations are shown as a bid/offer rate. The dollar lies at the heart of foreign exchange dealing, as most transactions involve moving in and out of the dollar. Sterling and currencies which were linked to sterling