Purchasing power is clearly determined by the relative cost of living and inflation rates in different countries. The purchasing power of a currency refers to the quantity of the currency needed to purchase a given unit of a good, or common basket of goods and services. The alternative to using market exchange rates is to use purchasing power parities (PPPs). However, not all countries trade the same proportion of their income and output, so currency values are not determined on a consistent basis. Secondly, market exchange rates are determined by demand and supply of currencies, which reflect changes in imports and exports of traded goods and services. Clearly, this is more to do with changes in the exchange rate than changes in the underlying state of the Japanese economy. For example, a one-month appreciation of the US$ by 5% against the Japanese Yen would reduce the dollar value of the Japanese economy by 5%. Using market exchange rates creates two main difficulties:įirstly, market exchange rates can quickly change, which artificially changes the value of the variable in question, such as GDP. Using market exchanges rates, such as $1 = ¥200, or:.When making comparisons between countries which use different currencies it is necessary to convert values, such as national income (GDP), to a common currency.
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