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Hi John,
Can you please explain the answer a bit regarding the law of one price?
and what happens if PPP Holds and does not hold?
Thanks in advance
Many factors affect the exchange rate between two countries. One of which is the relative rates of inflation – if this were the only factor then we would be able to predict changes in exchange rates if we knew the inflation rates using the purchasing power parity formula. In practice it is not the only factor and we can’t predict exchange rates.
Other than that I can’t add to what the examiner has written in his answer and what I say in my free lecture on this.
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Thank you john,
Regarding the “law of one price” what does this mean? couldn’t find anything in the bpp text on this.
Thank you
The of one price means that a devaluation in the currency can be compensated by raising prices. So if this law stands PPP theory that inflation determines exchange rates won’t apply. And a shift in exchange rates will be brought by a country losing its competitive advantage rather than difference in inflation rates.
I hope this is helpful
makhosazanemabaso: Please do not answer questions in the forum because it is the Ask the Tutor forum, and you are not the tutor (but please do help people in the general Paper P4 forum 🙂 )
Stafano: You don’t need to know the term ‘law of one price’, but it is simply referring to purchasing power parity, which is surely in the BPP text, and is also in my free lecture notes (and the lectures that go with them).
(It is chapter 24 of the lecture notes)
Please tell ur which lecture explains this part of purchasing power parity theory
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