Coursework for Quantitative Methods Essay Example | Topics and Well Written Essays - 2000 words

Coursework for Quantitative Methods - Essay Example The competitive markets will equalize the price of a similar good in the two countries when prices are expressed in similar currencies. For instance, a certain Television Set priced at 750 Dollars in Canada should cost 500 Dollars in United States when the exchange rate between the two countries is 1.50. Economists use two Purchasing Power Parity versions: Relative Purchasing Power Parity and Absolute Purchasing Power Parity. Absolute PPP is when the price level across countries is equalized. For instance, the exchange rate of Canada and US is computed by dividing the price level of Canada by that of the US. Assuming the exchange rate is 1.3 CAD per USD from 1.5 CAD per USD today. PPP theory implies the Canadian dollar will appreciate as USD depreciated. The relative Purchasing Power Parity refers to the degree of changes in the price level commonly known as the inflation rate. It says that appreciation rate of a currency is similar to the difference in the rate of inflation between the home and the foreign country. Assuming the inflation rate for Canada and US are 1% and 3% respectively, The US currency will depreciate against the Canada Dollar by 2% annually. Relative PPP withstands when the difference in inflation is very large. The concept is related to effect of trade and market arbitrage on the prices of similar products exchanged in multiple markets. In markets that are efficient, there must be a single price of those commodities in respective of their trading areas. The law of one price is also applicable to factor market. However, since the costs of the transaction and transport are positive, the law needs reformulation when applicable to spatial trade. Assuming we have two markets (Liverpool and Chicago) trading wheat and the wheat are transported from Chicago to Liverpool. The difference in the prices of wheat between the two markets should be similar to the cost of the transaction