Then, Thus the spot exchange rate is related to the price levels at home and abroad. The first equation seems to hold for one commodity that is fairly heavily traded such as wheat, oil, and gold and other metals. But there are many products that it does not apply to and of course depends on the government's international institutional framework.
Evidence seems to suggest that it fits moderately well to all traded goods as a whole.
Of course there are index number problems, transport costs, and trade restrictions that may influence the relationship. The formula seems to apply with somewhat less accuracy to all goods both traded and non-traded goods. Since the relationship deals with prices and prices are often sticky in one or both directions, the relationship holds much better in the long run. See figure 18.2 Money Prices and Inflation. Y is real output, the production of goods and services in the economy This form of the equation applies to goods and services produced so that pY refers to gross domestic product of the economic system.