Internal and External Purchasing Powers
Having understood the price level concept and its relationship with price index we can then look into the two different purchasing power principles: internal and external.
Internal purchasing power of a particular currency is a reflection of the value of how much a consumer can buy with the given amount of domestic currency in the particular country. In other words, that is the amount of goods and services that can be purchased with a pound in the United Kingdom, or alternatively a dollar in the United States. Over time the value of money is constantly decreasing and a pound 10 years ago could buy considerably more than a pound today. The CPI table is a perfect example that illustrates this process in real life: in 2013 consumer would have to spend £107.7 for goods that in 2010 could be bought for £100. Usually internal purchasing power level is measured in consumption bundles. That is how many of these consumption bundles can be bought for particular amount of domestic currency in home economy. For example if a consumption bundle of particular fixed goods and services in the UK costs £20,000 with £100,000 we could buy 5 of these bundles. This raises a question: if we would be able buy the same 5 bundles for £100,000 in the USA or any other country in the world? To answer this question we should analyse the external purchasing power.
External purchasing power of a currency reflects the value of how much a consumer can buy with a particular amount of home currency in a different country. In order to determine the external purchasing power of a pound in the USA, as per our example, we would need to convert the pounds into dollars and then calculate how many consumption bundles we would be ...
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...2.80$ in the USA. As we can see the prices in most of the countries are completely different. With Switzerland being the most expensive country to buy both BigMac (5.11$) and a tall latte at Starbucks (4.54$) and the least expensive country for a BigMac being China (1.23$) and Thailand (1.93$) for the tall latte.
The smaller table shows how strongly the local currency is either undervalued or overvalued against the US dollar. These valuations can be used to predict the appreciation or depreciation of a particular currency. Therefore it could be a reasonable factor to consider for the financial managers. Knowing how a particular currency would move in the future on the foreign exchange markets could prevent the managers from making decisions that might lead to a loss because of the fluctuations of currency in which most of the corporations transactions are settled.
Gross domestic product (GDP) is one of the best ways to measure how a country’s economy is doing. A main component in figuring the GDP is personal consumption expenditures. Personal consumption expenditures accounts for about two-thirds of domestic
“GDP measures the monetary value of final goods and services—that is, those that are bought by the final user- produced in a country in a given period of time (a quarter or a year). It counts all of the output generated within the borders of a country.” (International Monetary Fund. n.d.)
Thus, imports of American goods are under less competitive pressure to keep prices low. Thus, weak dollar benefits U.S. exports by making American goods cheaper in foreign countries. Foreign tourists can afford to travel and visit the United States. When the dollar is falling, foreign purchasing power is increasing. Purchasing power is the amount of value of a good or service compared to the amount that you paid.
The nominal exchange rate, the relative price of currencies of two countries. For example, if the exchange rate between the dollar A S and the Japanese yen is 80 yen per dollar . Japanese people who want to have dollars, ak early pay 80 yen for each dollar he bought. While the Americans who want to have the yen will get 80 yen for each dollar he was paid. When people refer to " exchange " between the two countries,
To calculate the change in his purchasing power (CPP) we can use the following formula:
Nominal gross domestic product refers to the value of GDP before accounting for the changes effected by inflation and deflation (Coyle 32). It shows the level of growth or shrinking of a country’s economy but does not put into consideration the consumer buying power. The value can be misleading to a nation because it does not reflect the real growth value of the economy.
The stability of currency values plays a significant role for economic and financial stability. It is not difficult to see the exchange rate fluctuations are widely regarded as damaging. As the movements of the exchange rate have significant and large effects on the trade balance, resource allocation, domestic prices, interest rate, national income and other key economic variables. Then can exchange rate movements be predicted by these fundamental economic variables?
The value of the US dollar relevant to other currencies is a major consideration for the Federal Reserve. If they prevent large changes in the value of the dollar, firms and individuals can comfortably plan ahead to purchase or sell goods abroad.
An Analysis of Gross Domestic Product (GDP). The current state of the economy in the United States has been slow in recent months. While the economy is not currently in recession, we may eventually fall victim to the first recession we’ve had in nearly ten years. The economy in general is showing growth, just not much.
International investing is something that many investors find that they can benefit from for many reasons. Two of the main reasons why investors choose to invest in foreign markets are growth and diversification. Growth allows investors the potential to take advantage of new opportunities in foreign emerging markets. International markets can potentially offer opportunities that might not be available in the United States. Diversification allows investors to spread out their risk to different markets and foreign companies other than those just in the United States allowing them to potentially create larger returns on their investment as well as reducing risks. (U.S. Securities and Exchange Commission, 2012) While investing internationally can be a very lucrative and rewarding decision, there are also extra risks involved with investing internationally. One of the main risks that international investors encounter is foreign exchange risk also known as currency risk. Currency risk is a financial risk that is created by contact with unforeseen changes in the exchange rate between two currencies. These changes can cause unpredictable gains or losses when profits from investments are converted from a foreign currency to the United Stated dollar. There are precautions that can be taken by investors to potentially lower their risk of currency value fluctuations and other risk factors that are present in international investing. (Gibley, 2012)
Other types of exchange rate risks are translation risk and so-called hidden risk. The translation risk relates to cases where large multinational companies have subsidiaries in other countries. On the financial statement of the whole group, the company may have to translate the assets and liabilities from foreign accounts into the group statement. The translation will involve foreign exchange exposure. The term hidden risk evolves around the fact that all companies are subject to exchange rate risks, even if they don’t do business with companies using other currencies. A company that is buying supplies from a local manufacturer might be affected of fluctuating foreign exchange rates if the local manufacturer is doing business with overseas companies. If a manufacturer goes out of business, or experience heavy losses, it will affect all the companies it does business with. The co...
Selling price is about $30-50. It is popularization price, For example “Espresso”, In the Pacific Coffee normal size is $35 but in the Starbucks is $40. It is cheaper than Starbucks. The working hours is about 8:00a.m.to 10p.m., open all year round.
According to The Star Online, up to 80% of the total group borrowings of RM7.49 billion were denominated in US dollar. Simultaneously, 8% of the total group borrowings were denominated in Euro currency. In other words, the total debt of the group that denominated in US currency worth at US$1.33 billion, approximately cost at RM5.91 billion. The total debt that denominated in Euro currency cost around €129.8 million, approximately cost at RM610.61 million. The high composition of debt in foreign currency caused the group extremely vulnerable to foreign exchange risk. A sensitivity analysis conducted by CIMB Research revealed that IOI could face RM148 million of loss or gain for foreign exchange translation risk with every RM0.10 rise/drop in Ringgit to US dollar exchange rate. Due to substantial losses on foreign exchange translation and fair value loss on derivative loss, the company predicted that the second quarter net profit of 2017 will be dropped by 98% to RM15.6 million, compared to the first quarter net profit recorded at RM703.7 million (Kok, 2017). Thus, foreign exchange risk is considered as high risk for
The foreign exchange market is one of important mechanism in the international business because foreign exchange is an intermediary for all nations in term of the growth of the economy. There are many functions of foreign exchange market in the global economy. In the international business, it uses the foreign exchange markets in four ways. First, the pay...
Knowledge of purchasing power: Consumer “purchasing power measures the value in money for which consumers may purchase goods or services” (Garman & Forgue, 2000, p. 9). It is related to the standard of living, the rate of inflation, income, our ability to buy and other. The standard national survey conducted by the Bureau of the Census for the Bureau of Labor Statistics measures the prices of goods and services by recording the rise or fall in prices of a number of chosen items for a specific period of time, to provide the best estimate of consumer purchasing