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Cassel was educated at the University of Uppsala and Stockholm University and served as a professor of economics at the latter (1904–33). His most important contribution was his concept of purchasing power parity. For example, if a barrel of oil sells for $25 in the United States and if one dollar buys 105 yen, then a barrel of oil should sell for 2,625 yen in Japan (25 × 105). In short, there should be parity between the purchasing power of dollars in the United States and their exchange value in Japan.
Cassel believed that if an exchange rate was not at parity, it was in disequilibrium and that either the exchange rate or the purchasing power would adjust until parity was achieved. The reason is arbitrage. If wheat sold for four dollars in the United States and for six hundred yen in Japan, then arbitragers could buy wheat in the United States and sell it in Japan and would do so until the price differential was eliminated.
Economists now realize that purchasing power parity would hold if all of a country’s goods were traded internationally. But most goods are not. If a hamburger cost two dollars in the United States and three dollars in Japan, arbitragers would not buy hamburgers in the United States and resell them in Japan. Transportation costs and storage costs would more than wipe out the gain from arbitrage. Nevertheless, economists still take seriously the concept of purchasing power parity. They often use it as a starting point for predicting exchange rate changes. If, for example, Israel’s annual inflation rate is 20 percent and the U.S. inflation rate is 4 percent, chances are high that the Israeli shekel will lose value in exchange for the U.S. dollar.