Definition
Parity Price refers to the price of a commodity or service that is linked to the price of another commodity or service, or to a composite average of prices over a selected previous time period. In this system, price variations between the two sets of commodities or services are monitored and presented on an index number scale where the number 100 denotes the status of parity.
Examples
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Agricultural Commodities: The U.S. government often uses parity price concepts to maintain the purchasing power of agricultural commodities. For instance, if the parity price of corn is set based on a prior period’s composite average, the modern price of corn would adjust to reflect current economic conditions and maintain consistent purchasing power for farmers.
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Currency Markets: In international currency markets, the term parity price can apply to exchange rates. For example, if the parity price of the Euro to the U.S. Dollar is set at 1.1, this affects the exchange rate policies and purchasing power parity between these two currencies.
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Interest Rate Pegging: Some financial instruments have interest rates pegged to a reference rate such as LIBOR (London Interbank Offered Rate). The interest rate of the financial instrument moves in tandem with variations in LIBOR, maintaining a form of parity.
Frequently Asked Questions (FAQs)
Q: What is the significance of the ‘100’ scale in parity price?
A: The ‘100’ scale signifies the status of parity. When the index number is at 100, it indicates that the prices are at parity. Changes in prices are reflected by movements away from the 100 mark.
Q: How does parity price impact farmers?
A: Parity price helps to ensure that farmers receive fair compensation adjusted for inflation and other economic factors. This helps to stabilize their income and maintain the purchasing power of their produce.
Q: Can parity prices fluctuate?
A: Yes, parity prices can fluctuate based on the economic conditions affecting the prices of the linked commodities or services.
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Purchasing Power Parity (PPP): A theory which suggests that in the long term, exchange rates should adjust so that an identical good or service costs the same amount in different countries.
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Commodity Price Index: An index that tracks the price of a commodity or basket of commodities over time.
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Price Pegging: The practice of fixing the price of a commodity based on another reference point, such as another commodity price or a time-based composite average.
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Inflation: The rate at which the general level of prices for goods and services rises, eroding purchasing power.
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Index Number: A statistical measure used to show changes in a variable or group of related variables over time.
Online References
Suggested Books for Further Studies
- “Commodity Price Dynamics: A Structural Approach” by Craig Pirrong
- “International Economics” by Dominick Salvatore
- “Principles of Economic Analysis” by Robert Dorfman
Fundamentals of Parity Price: Economics Basics Quiz
### What does ‘100’ signify in a parity price index?
- [ ] The actual price of the commodity
- [ ] A loss in purchasing power
- [x] The status of parity
- [ ] The maximum allowable price
> **Explanation:** In parity price indices, 100 signifies the status of parity, where the linked prices are considered balanced.
### Parity price helps stabilize the income of which group?
- [ ] Bankers
- [ ] Entrepreneurs
- [ ] Municipal workers
- [x] Farmers
> **Explanation:** Parity price helps stabilize the income of farmers by ensuring they receive compensation that reflects economic conditions and maintains purchasing power.
### The concept of parity price is often used in which sector?
- [x] Agricultural commodities
- [ ] Pharmaceuticals
- [ ] Automobile industry
- [ ] Technology sector
> **Explanation:** The concept of parity price is often used in the agricultural sector to maintain the purchasing power of commodities like corn or wheat.
### Which of the following is an example of price pegging?
- [ ] Seasonal discounts
- [ ] Promotional offers
- [x] Currency exchange rates linked to a stable currency
- [ ] Surge pricing in ride-sharing apps
> **Explanation:** Price pegging occurs when currency exchange rates are linked to a stable currency, ensuring stability in value and reducing fluctuations.
### If the parity price index falls below 100, what does it indicate?
- [ ] Prices are rising
- [x] Prices have fallen below parity
- [ ] Demand is increasing
- [ ] Supply is decreasing
> **Explanation:** If the parity price index falls below 100, it indicates that prices have fallen below the parity level.
### What is a key benefit of a parity price system?
- [ ] It eliminates inflation
- [x] It provides price stability
- [ ] It standardizes quality
- [ ] It boosts production
> **Explanation:** A parity price system provides price stability, enabling economic agents like farmers to plan and manage their incomes more effectively.
### Parity price is related to which of the following economic concepts?
- [x] Purchasing Power Parity (PPP)
- [ ] Fiscal Policy
- [ ] Tariff Barriers
- [ ] Trade Embargo
> **Explanation:** Parity price is closely related to the concept of Purchasing Power Parity, which maintains that exchange rates should adjust for equivalent purchasing power.
### What does pegging a price to a composite average involve?
- [x] Linking current prices to an averaged price from a prior period
- [ ] Setting prices based on yearly sales data
- [ ] Pegging to the highest price in the market
- [ ] Fixed pricing without fluctuations
> **Explanation:** Pegging a price to a composite average involves linking current prices to an average derived from previous pricing data, adjusting as per historical conditions.
### Which of the following best describes the result of an effective parity price system?
- [ ] Prices fall below break-even points
- [ ] Supply outstrips demand
- [x] Economic stability and predictability
- [ ] Increased volatility in prices
> **Explanation:** An effective parity price system promotes economic stability and predictability, essential for planning and sustainable financial health of sectors dependent on it.
### What is necessary for setting accurate parity prices?
- [ ] Market monopolization
- [x] Historical price data and relevant economic indicators
- [ ] Eliminating all competitors
- [ ] Standardized global pricing
> **Explanation:** Accurate parity prices require robust historical price data and relevant economic indicators to ensure prices are representative of real economic conditions.
