Author Question: Discuss the effects of ongoing inflation based on the PPP theory. What will be an ideal ... (Read 23 times)

burchfield96 · **on:** Jun 30, 2018

Discuss the effects of ongoing inflation based on the PPP theory.

What will be an ideal response?

Question 2

In 1975, wage levels in South Korea were roughly 5 of those in the United States.

It is obvious that if the United States had allowed Korean goods to be freely imported into the United States at that time, this would have caused devastation to the standard of living in the United States, because no producer in this country could possibly compete with such low wages. Discuss this assertion in the context of the Ricardian model of comparative advantage.

kjo;oj · **Reply #1 on:** Jun 30, 2018

Answer to Question 1

Other things equal, money supply growth at a constant rate eventually results in ongoing price level inflation at the same rate as the money supply growth, but changes in this long-run inflation rate do not affect the full-employment output level or the long-run relative prices of goods and services.

The interest rate, however, is affected by continuing growth in the money supply (inflation). This can be shown by combining PPP with the interest parity condition. To show it analytically, recall that the condition of parity between dollar and euro assets is:
R = + ( - )/
And according to relative PPP:
( - )/ = US,t - E,t
If people expect relative PPP to hold, the difference between interest rates offered by dollar and euro deposits will equal the difference between the expected inflation rates, over the relative horizon, in the U.S. and Europe.

Answer to Question 2

Regardless of relative wage levels, the United States would be able to provide its populace with a higher standard of living than would be possible without trade. Also, low wages tend to be associated with low productivities.