Prices and Exchange Rates. Purchasing Power Parity. Purchasing Power Parity. Similar goods tend to sell for similar prices worldwide. Law of One Price
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