ECON 002 Lecture Notes - Lecture 23: Arbitrage, Substitute Good, Purchasing Power Parity
Document Summary
Ope(cid:374) eco(cid:374)o(cid:373)y (cid:894)co(cid:374)t"d(cid:895) and open economy: advanced topics. The law of one price (or purchasing power parity) suggests the notion that, everything else the same, a good should sell for the same price in all markets across the world. Suppose coffee sells for /pound in seattle and for the equivalent of. /pound in vancouver, and can be almost costless transported. There is an opportunity for arbitrage here, making a quick profit by buying coffee in. Such arbitrage drives up the price in seattle and drives down the price in vancouver, until the two prices are equal. If the ppp holds, monetary policy affects nominal exchange rates. If m , the(cid:374) p i(cid:374) the lo(cid:374)g ru(cid:374), the(cid:374) it (cid:373)ust also (cid:271)e the (cid:272)ase that, if e = 1, a(cid:374)d m , then e = pf / p . It is possible in principle for country to manage their currency exchange rates through monetary policy and achieve competitive devaluations.
