CHAPTER 3

Purchasing Power Parity

A currency is misvalued when the actual foreign exchange (FX) rate is not equal to the intrinsic FX rate. In the global business environment, the success of a manager’s strategic decisions may well depend on whether a currency is viewed as overvalued, undervalued, or correctly valued. So managers need to understand the basics of intrinsic FX rates.

This chapter covers the connection between FX rates and goods prices, and the role of goods prices in intrinsic FX rates. You will learn about long-run intrinsic FX rates based on purchasing power.

FX Rate Changes and Foreign Demand for Goods

You have learned that in principle, and other things the same in a flexible FX rate system, a drop in the foreign demand for ...

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