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Purchasing Parity Expalin purchasing parity. Identify the inflation rate of your home country and some well?known...

Purchasing Parity Expalin purchasing parity. Identify the inflation rate of your home country and some well?known foreign country. Then identify the percentage change of your home currency with respect to that foreign country. Did the currency change in the direction and by the magnitude that you would have expected according to PPP? If not, offer possible reasons for this discrepancy.

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Answer #1

Lets assume home country as Euro.
Inflation is USA over past year =2.14%
Inflation Eurozone=1.20%

Euro/USD rate a year ago =1.1078 USD per Euro
Euro/USD rate today= 1.1975 USD per Euro
Rate today as per PPP=1.0120/1.0214*1.1078=Euro 1.0976 pe rUSD.

The currency change did not happen in the direction as per PPP. The reasons for this may be:

The law of one price assumes not transportation cost which is not possible.
The perfect market not being present
Information flow is restricted.

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