Purchasing Power Parity

[attachment=18051]

IMPORTANCE OF IB
1. Helps as growth strategy: - Geographic expansion may be used as a business strategy. Even though companies may expand their business at home.
2. Helps in managing product life cycle: - every product has to pass through different stages of product life cycle-when the product reaches the last stages of life cycle in present market, it may get proper response at other markets.
3. Technology advantages: - some companies have outstanding technology advantages through which they enjoy core competency. This technology helps the company in capturing other markets.
4. New business opportunities: - business opportunities in overseas markets help in expansion of many companies. They might have reached a saturation point in domestic market.



What is Purchasing Power Parity?

Purchasing power parity (PPP) is a theory which states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries. This means that the exchange rate between two countries should equal the ratio of the two countries' price level of a fixed basket of goods and services. When a country's domestic price level is increasing (i.e., a country experiences inflation), that country's exchange rate must depreciated in order to return to PPP.


Purchasing-power parity theory. A theory which states that the exchange rate between one currency and another is in equilibrium when their domestic purchasing powers at that rate of exchange are equivalent.
In short, what this means is that a bundle of goods should cost the same in Canada and the United States once you take the exchange rate into account. To see why, we'll use an example.



Purchasing Power Parity and the Long Run
Purchasing-power parity theory tells us that price differentials between countries are not sustainable in the long run as market forces will equalize prices between countries and change exchange rates in doing so. You might think that my example of consumers crossing the border to buy baseball bats is unrealistic as the expense of the longer trip would wipe out any savings you get from buying the bat for a lower price. However it is not unrealistic to imagine an individual or company buying hundreds or thousands of the bats in Mexico then shipping them to the United States for sale. It is also not unrealistic to imagine a store like Walmart purchasing bats from the lower cost manufacturer in Mexico instead of the higher cost manufacturer in Mexico