Power parity because in that way the relative price levels in the two countries will stay the same (measured

In a common currency). For example, if the US price level rises by 10 percent but the European

Price level by only 5 percent, the PPP value of the European price should appreciate by approximately

Percent. Change in the relative values of the two currencies compensates exactly for differences in

National inflation rates. If indeed the actual exchange rate equals the PPP rate, the competitive positions

Of firms in the two countries will remain unchanged. American firms, even though domestically

Facing a higher inflation rate, will still be able to sell their output to Europe just as before because the

Exchange rate will have adjusted to offset the effect of higher US prices.

The PPP theory seems to work well in the long run when the differences in inflation rates between

Two countries are relatively large. When such inflation rate differences are not big, other,

Market-oriented forces enter.

Vocabulary Notes to Text 6.7.1.2

Purchasing power parity — паритет покупательной способности

To reflect — отражать

Relative changes — относительные изменения

To offset — возмещать (компенсировать)

Value — значение

6.7.1.3. Read and translate the text “From Exchange Control Practice” and make an account

O f how it is exercised.

From Exchange Control Practice