MGEC61H3 Chapter 15: Chapter 15 Notes

The price of an iPhone 5s in the U.S. is $399. The table below lists the income per capita and prices of the same iPhone in four different countries in 2014 in their own currencies.

What is the purchasing power parity based on the exchange rate between the two currencies?

In the long run, exchange rates reflect purchasing power parity (PPP). This theory called the law of one price, aggregates and generalizes the idea that the same good must sell for the same price, in the same currency units, regardless of where it is produced. The following questions consider how PPP and the law of one price work and whether they can explain long-run exchange rate movements.

PPP may not hold because:

A. The law of one price applies, on average, to all goods.

B. Countries are gradually reducing trade restrictions.

C. All goods and services can trade at a relatively low cost.

D. Goods produced in different countries vary greatly in quality.