International Economics

Flashcards related to exchange rates, purchasing power parity, and goods market equilibrium.

Law of One Price

The exchange rate must equal the ratio of the goods' prices expressed in the two currencies.

Purchasing Power Parity (PPP)

The macroeconomic counterpart to the microeconomic law of one price (LOOP).

Absolute PPP

Price levels in two countries are equal when expressed in a common currency.

Real Exchange Rate

The relative price of baskets of goods between two countries.

Real Depreciation

More home goods are needed to buy foreign goods.

Real Appreciation

Fewer home goods are needed to buy foreign goods.

Dollar is Strong/Euro is Weak

Foreign goods are cheap relative to home goods (qUS/EUR < 1).

Dollar is Weak/Euro is Strong

Foreign goods are relatively expensive (qUS/EUR > 1).

Purchasing Power Parity Implication

The exchange rate at which two currencies trade equals the relative price levels of the two countries.

Inflation

The rate of change of the price level.

∆E$/€,t / E$/€,t

The rate of exchange rate depreciation in Home, given by (Et+1 - Et)/E_t.

π𝑈𝑆,𝑡

The rate of inflation in the U.S., given by (PUS,t+1 - PUS,t)/P_US,t

π𝐸𝑈𝑅,𝑡

The rate of inflation in Europe, given by (PEUR,t+1 - PEUR,t)/P_EUR,t

1

Purchasing power parity (absolute PPP) only holds if the real exchange rate qUS/EUR is equal to what?

𝑞𝑈𝑆Τ𝐸𝑈𝑅

Relative price of basket in Europe versus U.S.

𝑃𝐸𝑈𝑅

European price of basket expressed in $

𝑃 ต 𝑈𝑆

U.S. price of basket expressed in $

Nominal Exchange Rate

The exchange rate for currencies.

𝑃 ൗ 𝑈𝑆 𝑔 / 𝑃𝐸𝑈𝑅 𝑔

Ratio of goods′prices

Absolute PPP Formula

𝐸 ถ $Τ€ Exchange rate = Τ 𝑃𝑈𝑆 /𝑃𝐸𝑈𝑅

Relative PPP Formula

∆𝐸$Τ€,𝑡 / 𝐸$Τ€,𝑡 = 𝜋𝑈𝑆,𝑡 − 𝜋𝐸𝑈𝑅,𝑡

Real Depreciation

Home has experienced a when the real exchange rate rises

Real Appreciation

Home has experienced a when the real exchange rate falls

Dollar is Strong/Euro is Weak

Term for when the euro is undervalued and the dollar is overvalued

Dollar is Weak/Euro is Strong

Term for when the euro is overvalued and the dollar is undervalued