Purchasing power parity (PPP) theory is a macroeconomic application, which postulates that an identical commodity traded across many nations should have the same prices relative to the prevailing exchange rates. The Big Mac index shows a big difference in selling prices of the product across several countries, which challenges the authenticity of this theory. The case study survey cannot provide exhaustive reason to render the theory in question impractical. Many countries manipulate their currencies relative to the dollar, which shows a disguised difference in exchange rate and value (McEachern, 2012).
For instance, many countries strive to protect their domestic products from imports; therefore, there is a tendency of imposing more tax that bids up the prices relative to the actual price. Various countries create imperfections in the money market to counteract effects of inflationary market manifestation and influence investment and savings decisions. The case study generalizes on imperfect market economies, while this theory holds; it can only be adequately tested in an open international trade arena, which may not actually exist (McEachern, 2012).
International trade theorizes that a given country is willing to trade with a partner that offers cheaper goods relative to domestic goods. China’s strategy to lower their currency value is an aim to attract US consumers by creating a lower opportunity cost of their goods in comparison to US commodities. This gives a comparative advantage in importing Chinese goods than producing and purchasing domestically. China has a primary goal of making its products gain foot in the market through a predatory strategy that makes its products more affordable, hence evoking irresistible purchasing urge from US buyers (McEachern, 2012).
China maintains a lower currency value through monetary interventions that increase the money supply in their economy. Effects of this measure trigger the law of demand and supply between dollar and Yuan in the Chinese forex market, where large supply of Chinese currency makes a dollar inadequate hence more powerful. This is maintained through a combination of trade restrictions and money market regulations by the Chinese central bank (McEachern, 2012).
- Balance of payments cannot all be in surplus because it results from deficits from other countries. The British currency is in high demand due to its low supply owing to its strong purchasing power. In a flexible exchange rate, the market forces are left to interplay relative to imports and exports market. A concept of comparative advantage in production of export products and demand for the goods in various countries create a varied exchange rate.
- Foreign aid is the monetary assistance accorded by large economies to a country to finance domestic activities. This is common to developing nations and helps remarkably in laying down development foundations for economic growth. However, this aid leads to accumulation of external debts in developing nations that they repay with interest. It fosters economic development but takes long due to burden of payment process.
- Trade makes countries better off due to benefits from comparative advantage in production of goods. Countries have different factor abundance which allows mutual benefit from their trading relations. Tariffs in US job market reduce loss of expatriates to other nations and influence domestic employment through creation of opportunities for skilled elites. Generally, trade restrictions are common due to the benefit of the imposing countries since they succeed in protecting an economy from external imperfections.
- Developing economies are characterized by weak industrial production as compared to large economies. International trade help developing countries market their products in the international markets, hence participating in the global business market share. However, the developed economies with established brands in international market pose high competition and bully the developing nations.
- Bretton woods system was tool of maintaining the fixed exchange rate world in early 19th century relative to the US dollar. The foreign countries with high currency strength could sell their currency in large quantities to suppress the value, while those with law value would purchase dollars to raise their currency value. This system destabilize when US made the dollar flexible in the exchange market. Under the flexible exchange rate, there is currency instability due to dynamics of interest rates and inflation in the world.
McEachern, W. A. (2012). ECON Macro 3 (3rd Ed). Mason, OH: South-Western.