Understanding Purchasing Power Parity

What does Purchasing Power Parity (PPP) aim to explain?

• PPP measures the total amount of goods produced in a country.

• PPP explains the relationship between exchange rates and the relative purchasing power of currencies.

• PPP is a method for calculating interest rates.

• PPP focuses on the speed of currency exchange transactions.

How does PPP relate to exchange rates between currencies?

• PPP indicates that exchange rates are fixed and do not change over time.

• PPP states that currencies should always be exchanged at their nominal values.

• PPP suggests that exchange rates are determined solely by interest rates.

• PPP relates to exchange rates by suggesting that exchange rates should adjust to equalize the purchasing power of different currencies.

What is the 'law of one price' in the context of PPP?

• The law of one price indicates that currency exchange rates are irrelevant to pricing.

• The law of one price states that prices can vary significantly between markets.

• The law of one price asserts that identical goods should have the same price in different markets when expressed in a common currency.

• The law of one price applies only to services, not goods.

What are some factors that can disrupt the law of one price?

• Transportation costs, tariffs, taxes, product quality differences, market segmentation, information asymmetry.

• Currency fluctuations

• Seasonal demand changes

• Consumer preferences

Why is the practical application of PPP considered complex?

• Inflation rates have no impact on PPP calculations.

• The practical application of PPP is considered complex due to varying consumption patterns, inflation rates, and exchange rate fluctuations.

• Exchange rates are always stable and predictable.

• PPP is simple due to uniform consumption patterns.

How would you calculate the exchange rate using PPP?

• PPP exchange rate = Price of basket in Country A - Price of basket in Country B

• PPP exchange rate = Price of basket in Country A * Price of basket in Country B

• PPP exchange rate = Price of basket in Country A / Price of basket in Country B

• PPP exchange rate = Price of basket in Country A + Price of basket in Country B

What is an example of a product used to illustrate PPP?

• Big Mac

• Whopper

• Taco

• Pizza

In what ways can transportation costs affect PPP?

• Transportation costs can distort price levels and affect the accuracy of PPP.

• Transportation costs only affect local markets, not PPP.

• Higher transportation costs always increase PPP.

• Transportation costs have no impact on PPP.

What role do tariffs play in the concept of PPP?

• Tariffs distort prices and can lead to deviations from purchasing power parity.

• Tariffs increase purchasing power parity directly.

• Tariffs have no effect on international trade prices.

• Tariffs simplify the calculation of purchasing power parity.

How does inflation impact the validity of PPP?

• Inflation increases the accuracy of PPP calculations.

• Inflation can distort the relative prices and purchasing power, undermining the validity of PPP.

• Inflation stabilizes relative prices across different currencies.

• Inflation has no effect on purchasing power parity.