Explain the law of one price and the theory of purchasing power parity. Why doesn't purchasing power parity explain all exchange rate movements in the short run? What factors determine long-run exchange rates?

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7 August, 10:32

Explain the law of one price and the theory of purchasing power parity. Why doesn't purchasing power parity explain all exchange rate movements in the short run? What factors determine long-run exchange rates?

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Megan Bean · Answer 1

The law of one price establishes that the product or service price will remain the same for all the entire world.

Explanation:

The law of one price establishes that the product or service price will remain the same for all the entire world. It is necessary to take into account for this law that the price of the currency needs to be also the same and that the price of the product or service would not be affected by other factors such as additional buyers or sellers in the market.

On the other hand the purchasing power parity refers to the idea of an equilibrium of currencies in exchange rates, it means that the power for purchasing will be represented in the same way in the different countries, and it is important to mention that this theory is base in the law of one price.

The the long run equilibrium is an idea that in theory represents all the equilibrium of prices, quantities, and markets in general; on the other hand, for the short run equilibrium there are some limitations in which the market cannot be explained as properly and fully balanced.