Question

Reconstruct the following: asset approach, balance of payment, and purcashing power parity.

Answer 1

A.a: This is the approach of valuation of business. In this approach the net asset value (NAV) of a company is calculated by subtracting total liabilities from the fair market value of assets. This system is useful while understanding the worth of investment --- at the increasing NAV such investment becomes worthy.

BOP: This is the currency value of all transactions of a country with other countries in a year.

Basically BOP indicates 0 balances, since liabilities could be recovered through assets. BOP = Assets – Liabilities = 0. But in actual it happens hardly, like in the US economy.

In recent few years the US import is higher than the US export, causing trade deficit. Such thing increases liabilities, causing BOP deficit. In the year 2014, the BOP deficit was around $490,000 million; which took rise in 2015 to around $500,000 million. The large change is increasing import by the country.

Although the import is high, country’s export also reaches the number-1 position. The US export is the highest compare to other countries. But such increasing inflows also can’t reduce the deficit because of more increasing outflows.

(PPP): The theory indicates, if the purchasing powers in two different countries are same, their exchange rates will be in equilibrium.

If inflation occurs in the US and it occurs in more speed compare to other countries, its currency, dollar, would be less valuable to other countries. This indicates that the exchange rate of dollar with other country’s currency would increase.

Suppose the exchange rate between pound and dollar before inflation is 1 pound = 1.5 dollar. If inflation occurs it might be 1 pound = 2 dollars.

The currency would be demanded more if it has higher amount of purchasing power. Before inflation the US dollar was more demanded, since 1 pound is spent to purchase only 1.5 dollar. Once the inflation occurs, the purchasing power of dollar goes down and it becomes less demanded. On that time, 1 pound is still spent but to purchase more dollars, 2 dollars.