Chapter 7

Prices, Exchange Rates, and Purchasing Power Parity


The tendency for similar goods to sell for similar prices globally provides a link between prices and exchange rates. As prices change internationally, exchange rates must also change to keep the prices measured in a common currency equal across countries. In other words exchange rates should adjust to offset differing inflation rates between countries. This relationship between the prices of goods and services and exchange rates is known as purchasing power parity (PPP). It is important to study the relationship between price levels and exchange rates in order to understand the role of goods markets (as distinct from financial asset markets) in international finance. This chapter ...

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