Business Short Answer Questions
Purchasing Power Parity
Purchasing Power Parity (PPP) is a metric that compares currencies in different countries. Still, it can differ from exchange rates due to changes in demand and supply as well as tariffs in each location.PPP employs the law of one price, which assumes that a commodity’s price should be the same in every nation, so long as there are no trade barriers and transaction costs. For example, if a can of Fanta in the U.S costs $1.00 then, a can of Fanta in China should cost $ 1.00 after the USD has been converted into the Chinese currency. Since prices are determined by domestic supply and demand, prices of similar goods may vary in different countries leading to PPP differing from exchange rates. Also, tariffs augment the price of imported goods across countries leading to the disparity.
How a Deficit Occurs
A deficit occurs for a nation when it consumes more than it produces, and it can happen in several ways. First is when a country’s imports exceed its exports due to the lack of adequate capacity to produce its products. With a weaker domestic currency, exports become cheaper, making imports expensive in countries while exports become costly, making imports less economical in countries with a stable domestic currency. Second, a deficit can occur if a nation is desirable for foreign investment. For example, due to the U.S dollar’s reserve status, foreigners have to sell their goods to America to obtain the dollar. While a deficit can help a county avoid shortages of products, it may increase unemployment.