Naked Economics: Undressing the Dismal Science

This chapter deals with how economics works between countries. Wheelan starts by positing that in theory there should be no difference between economics within one country and between more than one. Political boundaries are arbitrarily imposed on geography, trade takes place, capital flows across such borders, investors seek the highest rate of return—all the same principles apply. The difference, however, is that countries use different currencies, none of which, as the previous chapter showed, have intrinsic value. Thus, the exchange rate should be determined by how much of each currency is needed to purchase the same amount of goods. The term economists use for this is purchasing power parity (PPP).

In fact, official exchange rates often vary a great deal from what PPP would indicate. This is because not all goods and services can be traded across national boundaries. For example, caregiving, car washes, and restaurant dining. For internationally tradable items, a savvy business person could take advantage of large price discrepancies to make a profit. Wheelan gives the example of $100 buying more goods in Mexico than in America. You could exchange US dollars for pesos and get more bang for your buck. Selling those goods in the US would provide a tidy profit.