INTERNATIONAL FINANCE NOTESReal Exchange Rate – Considers the Purchasing Power Parity

– The nominal rate does not include the Purchasing Power Parity When the Real exchange rate is equal to one – One bundle In one country equals one bundle in another country – Purchasing power parityProfit must be compared to its purchasing power to get a real feel for what the currency is actually worth (how many bundles can you buy for your profit) Cadillac or a piece of bread There are particular bundles that they use to measure Income = Revenue – Expenses

Revenue = What you sell

Revenue – Cost = Profit

Nominal Profit = Revenue for both countries added – firms (domestic costs)An increase in the general price level – Inflation

If the inflation rate rises at an equal amount in both countries than the isk is reduced to a nominal risk Price elasticity – ((Change in Q/Q)/Change in P/P)) 1+rs(t+1,a/b) = [1+pi(t+1,b)]x[1+s(t+1,a/b)]

1+pi(t+1,a)] How do we get this formula Learn to identify each part of the formulaPi(t+1) = Pi(t+1)-P(t)/P(t)Increase in the nominal exchange rate or an increase in the inflation rate can drive this equation upRelative purchasing power parity – No change in the real exchange rate Rate of change formula

1+s(t+1,$/E) The model for The real Exchange Risk slide = Zero – Not expecting the real exchange rate to changeCalculating the price level

P(t,+$) = SUMN i=1 WiP(t,i,$)

where P(t, i, +$) represents the dollar price of good i at time t,

wi represents the weight or consumption share of good i

P(t, $) is the dollar price level, the weighted average of the dollar prices of the N different goods and services.

Calculating the annual rate of inflation

Subtract 1 from the ratio of price idexesCumulative Rate of InflationRatio of price indexes ^ (1/number of years)Internal Purchasing Power of the dollar at time t is1/purchasing power of the dollar at…