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Burgernomics Burgernomics PPP essay Outlines the necessary components associated with writing about the discussion topic

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ECON 231
Huang Hui

Thomas Lypps 20232722 March 10, 2010 Burgernomics Purchasing Power Parity (PPP) is the ‘ideal’ that price levels in any two countries should be the same after the transfer/exchange of currency for trade. It is considered an ideal because it makes sense in a theoretical sense but in a practice it does not hold. PPP tends to fail because of three main things: non- traded goods, pricing to the market, and trade barriers. The basis to PPP is the Law of One Price, “abstracting from complicating factors such as transportation costs, taxes, and tariffs, the law of one price states that any good that is traded on world markets will sell for the same price in every country engaged in trade, when prices are expressed in a common currency.” 1 Relative PPP is based on the relative consumption and/or production of a given country. For example, Canadians may like to eat more blueberries than Britain, in which case, by supply and demand, they would be more expensive in Canada than in Britain if the production factors where the same. Interest rate parity is one of the other reasons why PPP does not hold, because of its influence in non- tradable goods, where a party is able to have a covered investment. It is considered covered because “Interest rate parity is a non-arbitrage condition which says that the returns from borrowing in one currency, exchanging that currency for another currency and investing in interest-bearing instruments of the second currency, while simultaneously purchasing futures contracts to convert the currency back at the end of the holding period, should be equal to t
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