PPP etc. Macro Exam

Nominal exchange rate

The price of one currency in terms of another; determines how much foreign currency you get for domestic currency. (Chapter 18)

Real exchange rate

Measures domestic goods relative to foreign goods: E = e × Pf / Pd; shows competitiveness. (Chapter 18)

Interpretation of real ER

E > 1 → foreign goods expensive; E < 1 → domestic goods expensive; E = 1 → equal prices (PPP holds). (Chapter 18)

Purchasing Power Parity (PPP)

The idea that identical goods should cost the same across countries; used to compare living standards. (Chapter 18)

Law of one price

If no trade barriers or transport costs exist, identical goods should have the same price everywhere. (Chapter 18)

Why PPP matters

Allows comparison of productivity and living standards across countries using a common price basis. (Chapter 18)

PPP deviations

Real exchange rate movements indicate deviations from PPP due to inflation differences or market frictions. (Chapter 18)

Market exchange rates

Can underestimate income in low‑income countries because many goods are cheaper there. (Chapter—