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Exchange Rates: Purchasing Power Parity quiz #1

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Termini in questo insieme (10)

  • What is the purpose of purchasing power parity (PPP) when comparing gross domestic product (GDP) between countries?
    Purchasing power parity (PPP) is used to compare the gross domestic product (GDP) between countries by adjusting for differences in price levels, ensuring that the same amount of money has the same purchasing power in each country. This allows for more accurate comparisons of economic output by accounting for variations in the cost of goods and services across countries.
  • How does the exchange rate need to change if the price of a Coke in the UK rises from £1 to £2 while it remains \$1 in the US to maintain PPP?
    The exchange rate must adjust so that \$1 exchanges for £2. This ensures that \$1 can still buy one Coke in both countries, maintaining purchasing power parity.
  • What is arbitrage in the context of purchasing power parity and exchange rates?
    Arbitrage refers to buying goods in a country where they are cheaper and selling them in a country where they are more expensive due to exchange rate misalignment. This process allows for profit until exchange rates adjust to restore PPP.
  • Why can't all goods and services be used to enforce purchasing power parity between countries?
    Not all goods and services are tradable internationally, such as doctor visits. This limits the ability of PPP to equalize prices across countries for non-tradable items.
  • How do consumer preferences affect the validity of purchasing power parity?
    Consumer preferences can cause people in one country to value a product more and pay a higher price for it. This willingness to pay more disrupts the equalization of prices that PPP predicts.
  • What role do trade barriers play in preventing purchasing power parity from holding in reality?
    Trade barriers like tariffs and import quotas restrict the free flow of goods between countries. These restrictions prevent prices from equalizing as PPP theory suggests.
  • What happens to the exchange rate if many people try to profit from arbitrage due to PPP deviations?
    The increased demand for the undervalued currency will cause its price to rise. This adjustment continues until PPP is restored and arbitrage opportunities disappear.
  • Why does PPP theory suggest that exchange rates should adjust when price levels change in one country?
    PPP theory holds that exchange rates move to equalize the purchasing power of currencies. If price levels change in one country, the exchange rate must adjust to maintain equal purchasing power.
  • Give an example of a non-tradable good that challenges the application of PPP.
    A doctor’s visit is a non-tradable good because it cannot be bought in one country and sold in another. This makes it impossible for PPP to equalize its price internationally.
  • How does an import quota affect the ability to profit from arbitrage in the context of PPP?
    An import quota limits the quantity of goods that can be brought into a country, restricting arbitrage opportunities. This prevents the price equalization process that PPP relies on.