Purchasing Power Parity

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The question of, “does relative purchasing power parity hold?” is one of great interest to economists. It is of interests to economist because it involves the percentage change of exchange rates and the difference between the percentage changes in national price levels. The definition of relative purchasing power parity is, “the percentage change in the exchange rate between two currencies over any period equals the difference between the percentage changes in national price levels” (Krugman 416). This is important to economists because it allows them to examine change in exchange rates and the percentage changes in prices to help predict what will happen next in the economies. Not only can economists compare the percentage change in exchange …show more content…
Both Purchasing power parity and absolute purchasing power parity do not hold in any situations in the economy. This allows economists to come to the conclusion that both these versions of the purchasing power parity do a poor job at explaining data. Although relative purchasing power parity also does not do a great job at explaining data, it does a better job than the other two in terms of the long run. An example form the book shows that it too does not do a great job in this situation. The example is, “Relative PPPP predicts that E¥/$ and PJ / PUS will move in proportion but, clearly they do not” (Krugman …show more content…
With the knowledge of exchange rates changes and price changes, economist can predict what may happen next in the world using the relative purchasing power parity. The reason that relative purchasing power parity is better than the other two is because neither of them really take into account barriers to trade and the transportation costs. Although using relative purchasing power parity to describe data is not the best way, it is better than the other two.

Works Cited
"Historic Inflation Mexico - CPI Inflation." Historic Inflation Mexico – Historic CPI Inflation
Mexico. N.p., n.d. Web. 11 May 2016.
Krugman, Paul R., Maurice Obstfeld, and Marc J. Melitz. International Economics: Theory &
Policy. Boston: Pearson Addison-Wesley, 2012. Print.
"Mexico Money Supply Growth - Data, Chart | TheGlobalEconomy.com.
"TheGlobalEconomy.com. N.p., n.d. Web. 11 May 2016.
"What Is the Current Inflation Rate?" What Is the Current U.S. Inflation Rate? N.p., n.d. Web.
11 May

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