The Authors State That Empirical Tests of Purchasing Power Parity

question 39

Essay

The authors state that empirical tests of purchasing power parity "have, for the most part, not proved PPP to be accurate in predicting future exchange rates." The authors then state that PPP does hold up reasonably well in two situations. What are some reasons why PPP does not accurately predict future exchange rates, and under what conditions might we reasonably expect PPP to hold?

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Definitions:

Exported Good

A product or service produced in one country and sold to buyers in another, contributing to international trade.

Consumer Surplus

The benefit gained by consumers because they are able to purchase a product for a price less than the maximum price they would be willing to pay.

Tariff

A tax levied on imports.

Domestic Price

The price of goods or services within a country's borders, as opposed to international or global prices.