Looking at the official exchange rate, you would expect a $1,000 computer in the US, to cost £500. But, many computers and electronic goods cost up to £1,000 making it effectively twice as expensive in the UK compared to the US.
What can explain this discrepancy in the price?
If the goods were produced in the US and exported to the UK, this could explain a small divergence in price. However, this is not even the case, many of the manufactured goods are produced in China and other Asian Countries
This is a more powerful argument. If living costs and wages are higher in the UK, then electronic shops would have to charge higher prices to cover the extra costs. Some things are more expensive in the UK e.g. petrol prices; but petrol is an insignificant % of the cost of buying a new compueter. )However, average wages in the UK are not higher than the US; also the cost of rent could not explain discrepancies of upto $1,000. Also the argument becomes even less convincing for an online retailer like Amazon, where renting costs are lower
Exchange Rates don't reflect Local purchasing Power.
In theory, if exchange rates are skewed like in our example, it should cause an appreciation in the dollar and decrease in the value of Pound Sterling. Because goods are much cheaper in the US, it makes sense for British consumers to buy from America. This increases demand for dollars and should cause the value of the dollar to rise. However, in practice it is difficult for people to import computers from America; there are customs, transport costs and inconvenience factors e.g. how do you return a faulty good to the US.
Many Factors influence Exchange Rates apart from local purchasing power.
This shows that there are many factors influencing exchange rates apart from basic competitiveness and attractiveness of goods. Furthermore, these discrepancies can last for a long time. The dollar is basically undervalued compared to Pound Sterling and the Euro. The weakness of the dollar could be attributed to:
- Lack of Confidence in the future of the US economy and strength of the dollar
- Large Current account deficit in the US.
- The US Dollar losing status as the world's reserve currency.