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Purchasing Power Parity - Assignment Example

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In the journal, “An Empirical Test of Purchasing Power Parity in Selected African Countries - a Panel Data Approach,” the author discusses the applicability of the Purchasing Power Parity theory in selected African countries. The author, Beatrice K. Mkenda has a vast focus…
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Purchasing Power Parity In the journal, “An Empirical Test of Purchasing Power Parity in Selected African Countries - a Panel Data Approach,” the author discusses the applicability of the Purchasing Power Parity theory in selected African countries. The author, Beatrice K. Mkenda has a vast focus on the panel unit root-test. The paper aims at testing whether the real exchange rates that are depicted are mean reverting or not.
In the article, the author goes through a number of selected African countries, pointing out the application of the Purchasing Power Parity. In her quest to depict the relation between three exchange rate indices, the author goes through all the relevant information pertaining the purchasing power of the chosen countries. The indices include the trade-weighted multilateral indices, import based multilateral indices, and the bilateral indices (Mkenda 39).
The theory, PPP, relates a country’s exchange rates to the relative price levels of other respective nations. For this reason, any nation with a high level of inflation has a depreciating currency, and thus loss of its value. The model has been questioned, and it fails to apply in a variety of cases, where the theory does not hold empirical evidence in regards to a country’s economic performance (Taylor 440).
In the article, African countries are seen to focus on minimal manufacturing activities, and rather rely on imported products. The countries face a number of limitations, among them being price takers rather than the decision makers. The nations take the market prices, affecting the states of their economy from time to time. Another major hindrance is the fact that these countries often make deals with exporters, where they get foreign aid, but have to rely on the country’s products. At such situations, the African nations have no choice but to take the fixed prices set in markets. Such limitations result to the depreciation of the countries’ currencies in the markets. Consequently, their exchange rates deteriorate and their purchasing power is therefore affected by the weakening currency.
The author explains the mechanism of the Purchasing Power Parity Theory and its institution in the African continent. Through the econometric method, the report develops a number of findings, which help develop a conclusion for the research. From the report findings, African nations have a negative multilateral index, in terms of exports, imports and trade weighted indices. The bilateral index is also negative, proving that the countries have a lower purchasing power than average. It, therefore, proves the reason for the deterioration of the economies, and the volatility of the markets in these nations (Mkenda 21).
The currencies of most African markets are determined by the prices in international markets, owing to the fact that the countries are more of price takers rather than the setters. The markets fluctuate often because of the constantly changing markets in the global scale. The information is depicted from the panel unit root, maximizing the credibility of the report findings (Mkenda 19).
The author successfully defines the application of the PPP theory using African nations and explains the reasons for the constant fluctuations. Through the panel unit root-test, the report successfully proves the credibility of the Purchasing Power Parity Theory as a tool for determining foreign exchange rates and the purchasing powers of different economies. The author depicts all the information to the reader, bettering the understanding and offering an empirical conclusion.
Work Cited
Mkenda, Beatrice Kalinda. An empirical test of purchasing power parity in selected African countries-A panel data approach. No. 39. 2001.
Taylor, Mark P. "Purchasing power parity." Review of International Economics11.3 (2003): 436-452. Read More
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