Describe how each of the following factors might explain why PPP is a better guide for exchange rate movements in the long run versus the short run

Describe how each of the following factors might explain why PPP is a better guide for exchange rate movements in the long run versus the short run:

1. transactions costs,

2. nontraded goods

other students’ work.

Transaction costs: In the long run, the average cost to the producer tends to fall gradually. Fixed costs become variable costs. The average cost associated with transaction costs will be decreased.

Nontraded goods: In the short run, for many reasons, (for example, high transaction costs and exchange rates), most goods and services are difficult to trade. Businesses cannot profit from the trade. But in the long run, businesses will find that they can make a profit by a large volume of product transactions without trading too often.

Transaction cost: in short run, cost is obviously more expensive as most of the inputs are fixed. In long run, as all inputs become variable cost, the average cost will be lower with respective of transaction will also decrease.

nontraded goods: In short run, non traded goods are difficult for trading as there are no international trade, there is no arbitraged opportunity for countries to trade these goods. In long run, advanced technology can help lower the cost, more business found profitable to trade with these goods.

Therefore, the above are the reasons why PPP is a better guide for exchange rate movement in the long run vs short run.