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Chapter 2
PB = PM + C (2.1)
where
PB,PM - the price of a ticket in Birmingham and Manchester respectively;
C - the transaction cost.
two identical goods must sell for a price that is the same
when translated into a common currency: e.g.,
PL = SPNY + C (2.2)
where
PL, PNY - price in London and New York respectively;
S - price of a dollar;
C - transaction cost.
where - Pdomestic
i prices of good number i
*
-P foreign
i prices of good number i*
to PPP:
P SP * (2.4)
Interpretations of PPP
1. price of a basket of goods ought to be the same
everywhere
2. money should buy the same basket of goods
wherever it is spent
3. the exchange rate adjusted for relative prices
should be 1.0
Q SP* / P
(2.5)
where Q
- real exchange rate,
S
- nominal exchange rate,
P* / P
- relative prices (foreign to domestic)
p s p* (2.6)
dp ds dp* (2.7)
where
dp, dp*- inflation rate of the home country and foreign country respectively;
ds - rate of currency depreciation.
Interpretation: either movements in the exchange rate reflect inflation
differentials or opposite
Copeland, Exchange Rates and International Finance, 6th edition
Pearson Education Limited 2014
Slide 2.8
P K ( SP* ) (2.4)
where
K - a constant;
- can be greater or less than unity;
- covers the total cost of conducting international trade.
(2.5)
p k s p*
225
British pound
200
French franc (until end-1998)
Swiss franc
Dollar Stronger ----->
Japanese yen
175 German deutschmark (Euro from 1999 onward)
150
125
100
75
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British pound
French franc (until end-1998)
175 Swiss franc
Japanese yen
German deutschmark ( Euro from 1999 onward)
125
100
75
1970
1971
1972
1973
1974
1975
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Year
2.6.1 Harrod-Balassa-Samuelson
Technology advances less rapidly in service sector than in
goods manufacturing, driving up marginal physical
product of labour (MPPL) in goods relative to service
sectors
Wage = value of MPPL across economy, as competition
operates and labour moves between sectors , so wage =
value of MPPL in goods sector, wage > value of MPPL in
services until service prices rise relative to goods prices
as time passes
Goods (services) mostly (non-) tradeable
Result: richer, more advanced economies look less
competitive in a comparison of real exchange rates based
on general price index
Copeland, Exchange Rates and International Finance, 6th edition
Pearson Education Limited 2014
Slide 2.15
qt qt 1 f [(qt 1 qt 1 ), zt 1 ] (qt 1 qt 1 )
where
qt 1- the log of real exchange rate at t-1;
qt 1- its equilibrium level at t-1;
zt - summarizes a list of other factors that may affect q
f - a measure of the extent to which a gap between qt 1
and is eliminated
qt 1 by the next periods change in the
exchange rate 0 < f < 1.
* /(1 )
PF PF (2.10)
where
PF*- price of a foreign product in its (foreign) country of origin
PF- price of a foreign product imported into home country
UK EU
where
PC*- price of a home-produced good in foreign country
-P
price of a home-produced product at home.
C
PC / PF (1 ) 2 PC* / P *
(2.12)
F