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Saturday, 30 July 2011

Article of the Week: The Economist

This article provides useful analysis of another indicator, The Big Mac Index, composed in 1986 by The Economist to help explain Purchasing Power Parity (PPP), look at Word of the Day. Although immense detail of PPP is NOT required in the AQA syllabus, it may be useful to understand more about exchange rates/inflation or merely for those looking to learn more beyond what’s required. Just mentioning it will show the examiner you have that extra knowledge. The article is a good read and explains the need for more ‘out of the box’ thinking for developing better indicators, not just for PPP.

Points to pick out from the article:

·  The Big Mac index has shown that the Euro is overvalued because the local currency against the dollar (measured by the Big Mac index) adjusted for GDP per person is greater than the raw index.

·  The yuan fairs pretty close against the dollar.

·  More sophisticated methods such as PPP requires more information and takes too long to produce, thus the Big Mac Index is a fairly good substitute.

For the charts to help the analysis:

Word of the Day

Purchasing Power Parity (PPP)

The purchasing power parity theory explains long term changes in the exchange rate. It explains that exchange rates are in equilibrium when their purchasing power is the same in each of the two countries. This means that differences in the purchasing power of two countries occur if the exchange rates differ. The theory predicts that if domestic inflation rises, e.g. by 5%, the exchange rate will fall by 5% thereby restoring the loss of competitiveness and enabling PPP to be reached. PPP is essentially the ‘law of one price’.