World Bank- its Objectives and Functions The International Bank for Reconstruction and

Development (IBRD), commonly known as World Bank, was result of the Bretton
Woods Conference. The main objectives behind setting up this international organisation
were to aid the task of reconstruction of the war-affected economies of Europe and assist
in the development of the underdeveloped nations of the world. For the first few years,
the World Bank remained preoccupied with the task of restoring war-torn nations in
Europe. Having achieved success in accomplishing this task by late 1950s, the World
Bank turned its attention to the development of underdeveloped nations. Over the time,
additional organisations have been set up under the umbrella of the World Bank.

As of today, the World Bank is a group of five international organisations responsible for
providing finance to different countries. As mentioned earlier, the World Bank is
entrusted with the task of economic growth and widening of the scope of international
trade. During its initial years of inception, it placed more emphasis on developing
infrastructure facilities like energy, transportation and others. No doubt all this has
benefited the under-developed nations too, but the results were not found to be very
satisfactory due to poor administrative structure, lack of institutional framework and non-
availability of skilled labour in these countries. Realising these problems, the World Bank
later decided to divert resources to bring about industrial and agricultural development in
these countries.

Assistance is extended to different countries for raising cash crops so that their incomes
rise and they may export the same for earning foreign exchange. The bank has also been
providing resources for education, sanitation, health care and small scale enterprises.
Today, the services provided by the World Bank have increased manifold. The World
Bank is no longer confined to simply providing financial assistance for infrastructure
development, agriculture, industry, health and sanitation. It is rather significantly
involved in areas like removal of rural poverty through raising productivity, increasing
income of the rural poor, providing technical support, and initiating research and
cooperative ventures. The group and its affiliates headquartered in Washington DC
catering to various financial needs are listed below on World Bank and its affiliates.
World Bank and its Affiliates

Purchasing Power Parity Theory of Exchange Rate

Purchasing Power Parity Theory of Exchange Rate is a theory, which establishes the
fact that the exchange rates between currencies are in equilibrium in the event of equality
in the purchasing power of each of the countries. This precisely means that the ratio of
the price level of a fixed amount of goods and services of the two countries and the
exchange rate between those two countries must be equivalent. PPP is based on the ‘Law
of One Price’. If the inflation rate within a country’s economy increases then the value of
the currency needs to depreciate to revive the PPP. In the absence of transportation and
other similar expenses, the competitive market will equalize the price of an identical
object in two countries when the prices are expressed by the same currency. However,
one has to be careful with the Law of one Price. The application of the Law of One Price
is contingent upon certain conditions. They are:
 A competitive market must be present in both the countries for the goods and services
 The law is only applicable to the goods that can be traded between the countries.
 Transport expenses and other transaction expenses must be checked since they are
considered hindrances in trading.
Types of PPP
There are two types of PPP. They are:
 Absolute Purchasing Power Parity that is based on the maintenance of equal prices in
two concerned countries.
 Relative PPP describes the inflation rate. This describes the appreciation rate of a
currency, which is decided by calculating the difference between the exchange rates of
two countries.

Calculation of PPP

Purchasing Power Parity is calculated by comparing the price of an identical good in both
the countries. The “Hamburger Index” in The Economist magazine presents the index in
a jovial manner every year. But the calculation is not free from problem because
consumers in every country consume different types of products. Another index is the
iPOD Index. The iPOD is considered to be one of the standard consumer products these
days. Hence PPP can be calculated by comparing its price.

The PPP is unable to display the right picture of the standard of living. There are certain
difficulties since the PPP number vary with specific amount of goods. PPP is very often
utilized to measure the poverty rates in countries.

Purchasing Power Parity Theory of Exchange Rate

A theory which states that the exchange rate between one currency and another is in equilibrium when their domestic purchasing
powers at that rate of exchange are equivalent.

In short, what this means is that a bundle of goods should cost the same in Canada and the United States once you take the
exchange rate into account. To see why, we'll use an example.

Purchasing Power Parity and Baseball Bats

First suppose that one U.S. Dollar (USD) is currently selling for ten Mexican Pesos (MXN) on the exchange rate market. In the
United States wooden baseball bats sell for $40 while in Mexico they sell for 150 pesos. Since 1 USD = 10 MXN, then the bat costs
$40 USD if we buy it in the U.S. but only 15 USD if we buy it in Mexico. Clearly there's an advantage to buying the bat in Mexico,
so consumers are much better off going to Mexico to buy their bats. If consumers decide to do this, we should expect to see three
things happen:

1. American consumers desire Mexico Pesos in order to buy baseball bats in Mexico. So they go to an exchange rate office
and sell their American Dollars and buy Mexican Pesos. As we saw in "A Beginner's Guide to Exchange Rates" this will cause
the Mexican Peso to become more valuable relative to the U.S. Dollar.
2. The demand for baseball bats sold in the United States decreases, so the price American retailers charge goes down.
3. The demand for baseball bats sold in Mexico increases, so the price Mexican retailers charge goes up.

Eventually these three factors should cause the exchange rates and the prices in the two countries to change such that we have
purchasing power parity. If the U.S. Dollar declines in value to 1 USD = 8 MXN, the price of baseball bats in the United States goes
down to $30 each and the price of baseball bats in Mexico goes up to 240 pesos each, we will have purchasing power parity. This is
because a consumer can spend $30 in the United States for a baseball bat, or he can take his $30, exchange it for 240 pesos
(since 1 USD = 8 MXN) and buy a baseball bat in Mexico and be no better off.

Purchasing Power Parity and the Long Run

Purchasing-power parity theory tells us that price differentials between countries are not sustainable in the long run as market
forces will equalize prices between countries and change exchange rates in doing so. You might think that my example of
consumers crossing the border to buy baseball bats is unrealistic as the expense of the longer trip would wipe out any savings you
get from buying the bat for a lower price. However it is not unrealistic to imagine an individual or company buying hundreds or
thousands of the bats in Mexico then shipping them to the United States for sale. It is also not unrealistic to imagine a store like
Walmart purchasing bats from the lower cost manufacturer in Mexico instead of the higher cost manufacturer in Mexico. In the
long run having different prices in the United States and Mexico is not sustainable because an individual or company will be able to
gain an arbitrage profit by buying the good cheaply in one market and selling it for a higher price in the other market (This is
explained in greater detail in “What is Arbitrage? ”).