Prices and Exchange Rates. Purchasing Power Parity. Purchasing Power Parity. Similar goods tend to sell for similar prices worldwide. Law of One Price
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Prices and Exchange Rates
Purchasing Power Parity
All goods must sell for the same price worldwide when converted into a common currency (if there is no transportation costs and no trade barriers).
That isE$/¥= PUSi / PJi for all i,
where PUSi = price of good i in US
PJi = price of good i in Japan
The equivalence of the exchange rate to the ratio of the foreign and domestic price levels
That isE$/¥= PUS/ PJ
where PUS= price level of US
PJ= price level of Japan
price level = price of a reference commodity basket
The equivalence of the percentage change in the exchange rate to the inflation differential (the difference of the foreign and domestic changes in price levels).
That is^E$/¥= ^PUS - ^PJ
or ^E$/¥= US - J
where ^()= % change in ()
US= inflation rate in US
J= inflation rate in Japan
Price discrimination: sells a commodity at different prices in different countries.
Different baskets in different countries.
And Blow Dry
Capita Income 1988
New York City