This week will discuss purchasing power parity and interest rate parity, both of which are important theories in global economics. First, the equation for purchasing power parity is simple – the domestic price should equal the exchange rate multiplied by the foreign price. So, suppose your shirt sells for 10 euros in Europe. If purchasing power parity holds, what should be the price of that same shirt in the United States if it takes 1.145 dollars to get one euro?
Now for the fun part of this week’s threaded discussion…an activity! Pick a good that is bought and sold internationally…the only condition is that you can find the price in the United States and the foreign price online (e.g., the iPhone sold in Mexico versus the United States). Next, find the foreign price, domestic price, and the exchange rate before “testing” the degree to which purchasing power parity holds. Then discuss PPP and IRP with your peers! As you progress in this week’s discussion, elaborate upon why PPP might better hold for certain goods for certain countries, but not for others? In other words, if we observe major departures from PPP, what might be the cause?