Business Finance Homework Help

1.According to the theory of purchasing power parity (PPP), what will happen to the value of the dollar (against foreign currencies) if the U.S. price level doubles and price levels in other countries remain constant? Why is the theory more suitable to analyzing events in the long run?

2.The Big Mac Price Index computed by the Economist has consistently found the U.S. dollar to be undervalued against some currencies and overvalued against others, which seems to call for a rejection of the purchasing power parity theory. Explain why the index may not be a valid “test of the theory.

After that give commont for these two:

1. According to the Purchasing Power Parity, if the price level of the U.S. doubles, than the value of the dollar will be reduced in half. As the U.S. levels double, U.S. good will become double more expensive than foreign goods. As U.S. goods prices increase consumers will begin to favor cheaper foreign goods. This will cause imports to increase. As imports increase the amount of foreign exchange conversions to dollars will increase.

2. In the long run the price of goods traded between two different countries should eventually be equalized by the exchange rate between those countries. The Economist prepares a price index of Big Macs in the U.S. Since the Big Mac includes untraded goods, a percentage of the price includes local products and thus the price will include regional factors. This is an example to show that index is not without its limitations in the purchasing power theory.

300 words will be fine.