Chapter 6 Part 1 - Foreign Exchange Rates

Economics Class 12
Macroeconomics

As per this theory

Exchange Rate adjust in long term

in such a way

that same products cost the same

whether measured in domestic currency (Rupees)

or

Whether measured in foreign currency (Dollars)

Assumption

(people are free to Purchase goods from any country)

There are no transportation costs

(There is no cost of bringing goods from India to USA)

### Transcript

What is Purchasing Power Parity theory? Suppose a Shirt cost Rs 400 in India and \$8 in USA Cost of Dollar is Rs 70 per Dollar Which shirt will sell more? Cost in India Rs 400 Shirt is cheaper in India Customer Prefer Indian Shirts More Demand For INR Dollar /INR Rate will decrease Until both shirt cost same Suppose Dollar Rate decreases to Rs 50/\$ Shirt Cost in India Rs 400 Shirt Cost in USA \$8 * 50 = Rs 400 Both Cost become same in long run This is called Purchasing Power Parity Theory What is Purchasing Power Parity Theory? PURCHASING POWER PARITY THEORY Number of goods a unit of Money can buy Equal in Different countries Theoretical concept As per this theory, Exchange Rate adjust in long term in such a way that same products cost the same whether measured in domestic currency (Rupees) or foreign currency (dollars) Assumption There are No Trade barriers (people are free to Purchase goods from any country) There are No Tansportation Costs (There is no cost of bringing goods from one country to another)