ACC 344 Lecture Notes - Lecture 12: Imperfect Competition, Perfect Competition, Aggregate Demand
PPP Theory
- PPP
- states all countries' price levels are same when measured in same currency
- purchasing power equal between countries
- all versions of PPP theory do poorly in explaining reality
Assumptions
- competitive markets, no transport costs, no official barriers to trade (perfect competition)
- ceteris peribus so only 1 variable changes
- prices adjust to maintain full employment
ISSUES
- transport costs/trade barriers creating nontradeables so non-competing goods can have different
prices
- differences in level of productivity (higher productivity generally means lower cost)
- imperfect competition
- methodological problems where consumer price indexes based on different commodity baskets
(cultural tastes/preferences)
- monetary and nonmonetary variables can explain PPP deviations
Absolute PPP
- exchange rate = relative price levels
E$/€ = Pus/Pe
Relative PPP
- percentage change in exchange rate between two currencies over any period = difference between the
percentage changes in national price levels
E$/€t - E$/€t-/E$/€t = πust-πet
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Document Summary
States all countries" price levels are same when measured in same currency. All versions of ppp theory do poorly in explaining reality. Competitive markets, no transport costs, no official barriers to trade (perfect competition) Ceteris peribus so only 1 variable changes. Transport costs/trade barriers creating nontradeables so non-competing goods can have different prices. Differences in level of productivity (higher productivity generally means lower cost) Methodological problems where consumer price indexes based on different commodity baskets (cultural tastes/preferences) Monetary and nonmonetary variables can explain ppp deviations. Percentage change in exchange rate between two currencies over any period = difference between the percentage changes in national price levels (cid:894)e$/ t - e$/ t-(cid:1005)(cid:895)/e$/ t = ust- et. R$ - r = e us - e e. Cp, a rise in country"s expected inflation rate will eventually cause an equal rise in the nominal interest rate that deposits of its currency offer.
