Economics Assignment: Demand, Supply, and Purchasing Power Parity

This assignment solution, designed for a Diploma in Management course, delves into key economic concepts. It begins by analyzing market data for coffee, examining the impact of price changes on demand, supply, consumer surplus, and producer surplus, with a graphical representation illustrating these dynamics. The solution then explores Purchasing Power Parity (PPP), explaining its theory, application, and the role of exchange rates in comparing economic conditions between countries. It uses the example of meat prices in the USA and Spain to illustrate PPP calculations. Finally, the assignment discusses the government's role in exchange rate policy to maintain currency purchasing power and stability, including strategies for currency appreciation.

Running head: DIPLOMA IN MANAGMENET
BUSINESS MANAGMENET
Name of Student:
Name of University:
Author Note:

1DIPLOMA IN MANAGMENET
A
O
B
C
D
F G
S
D
DWL
H
Excess Supply
I
SET-1
Answer 5:
From the given market data regarding the demand and supply schedule of the 100 gm coffee one
can say that at price $6 the quantity demanded and supplied is equal to 81 unit. If we look at the
data closely we will find that for one unit change in price that is price being $6 to $7 make sthe
demand 68 unit and supply 98 unit. This explains that demand falls by 13 unit and supply rises
by 17 unit. Now the market set price has been mentioned to rise and reach $6.25. This has led to
fall in consumer surplus and producer surplus. Burden on consumers are more than producers.
(Source: Author)

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Initially the price was $6 at B and now the price increased to $6.25 reflected by D which acts like
price floor prevailing above the market equilibrium price. The initial consumer surplus was
reflected by the are AOB and producer surplus was the area BOC Now the consumer surplus has
reduced to area AFD and producer surplus has increased to CHFD where DFIB area is gained by
the producers due to rise in price. Clearly the area FOH is loss of total surplus as part of both
consumer and producer surplus leaks out of the total surplus which was area AOC initially and
now has become The area AFHC.
SET-3:
Answer1:
Purchasing Power Parity (PPP) is a standardized metrics devised to analyze the difference of the
economic conditions and consequent difference in standard of living and economic parameters
between countries of the world across time series. The theory of PPP explains the comparison of
currencies in different countries through an approach based on common basket of goods. The
theory suggests exchange rate between two nations is equivalent to the ratio of the purchasing
power of the respective currencies. Differences in prices prevailing in the markets of different
nations stem from varied inflation rate in national economy and presence of trade and transaction
cost. Moreover exchange rates are different. The Purchasing Power Parity focuses on the concept
that builds law of one price. This further explains that when there is no presence transaction cost
and trade barriers goods of same type will be sold in same price in different countries’ markets
given that the prices are converted and expressed in same currency.

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S = exchange rate of currency 2 to currency 1
P1 = Cost of good Y is currency 1
P2= Cost of good Y in currency 2
Suppose 100 gm of meat costs US$10 in USA and the same meat costs EUR 5 in Spain. Even
though the good is same the prices differ due to difference in economic and political factors.
Now following the formula of PPP we get the exchange rate of Euro in Spain to US dollar as
S= 10/5 = $2 => EUR 1 = DOLLAR 2
That is to get one unit of Euro one needs to give $2. Price of one unit of euro is 2 when
converted in dollar. Now if we transfer the price of meat in euro to dollar then the converted
price of meat in dollar becomes $10 only that is the market price of the mean in USA. One unit
of euro comes from giving $2 hence 1 euro has more purchasing power than one unit dollar itself
in the US market. The PPP theory doesn’t say that one unit of currency would buy same amount
in different countries but it makes the prices of good in different markets same through
equalization of exchange rate and relative prices of that good.
Answer 2:
The role of government lies in the adoption of proper exchange rate policy so that the purchasing
power of the currencies become equal while exchange rates remaining close to each other. The
greater the deviation between currencies in the exchange rate, the greater is the value of one
currency in terms of others. In the above example one unit euro carries purchasing power

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equivalent to 2 unit of dollar. Had the exchange rate become less than 2 and more close to 1, the
difference of this purchasing power would have reduced making the currencies have close
values. So the target of the government is to appreciate the domestic currency which is possible
by increasing the foreign reserve. If the government in USA wants to appreciate its own currency
then it needs to supply more of euro and make addition to the US foreign exchange reserve. This
would make the price of euro fall and per unit of euro lesser amount has to be paid. The
exchange rate modification can take place by revaluation of the home currency through flexible
or pegged exchange rate system.

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REFERENCE:
Bodie, Z. (2013). Investments. McGraw-Hill.
Frenkel, J. A., & Johnson, H. G. (Eds.). (2013). The Economics of Exchange Rates (Collected
Works of Harry Johnson): Selected Studies (Vol. 8). Routledge.
Hildenbrand, W. (2014). Market demand: Theory and empirical evidence. Princeton University
Press.
Rios, M. C., McConnell, C. R., & Brue, S. L. (2013). Economics: Principles, problems, and
policies. McGraw-Hill.