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Suggest_answers_1 - pEEP151/Econ171 Fall 2007 Alain de...

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pEEP151/Econ171 Alain de Janvry Fall 2007 Melissa Hidrobo, Lourdes Rodriguez Exercise 1 SUGGESTED ANSWERS Using indicators to characterize development patterns Due September 13, 2007 I. How much difference do PPP exchange rates make in measuring well-being? To compare well being across countries, development economists have used GDPpc measured in US dollars at the PPP exchange rate. 1. Explain why they do this as opposed to using GDPpc measured in US dollars at the official exchange rate. Development economists use the GDPpc-PPP instead of GDPpc at the official exchange rate because the official exchange rate does not measure the relative domestic purchasing power of different currencies. The PPP on the other hand measures the number of units in a foreign country’s currency required to purchase the identical quantity of goods and services as a dollar would buy in the US. 2. Using the data in Worksheet 1 for 156 countries taken from the World Development Indicators (http://devdata.worldbank.org/dataonline/old-default.htm), graph the schedules of GDPpc-nominal e and of GDPpc-PPP e against the country’s rank based on its GDPpc at the nominal exchange rate. (e denotes exchange rate.) GDPpc-nominal and of GDPpc-PPP against the country’s rank based on its GDPpc at the nominal exchange rate 0 10000 20000 30000 40000 50000 60000 Countries ranked based of GDPpc US$ (only some countries' labels appear in the figure) US dollars US dlls PPP GDPpc-nominal e GDPpc-PPP 1 5/12/09
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3. For which countries does the PPP adjustment make a negative difference? Explain why. Lebanon United Arab Emirates Sweden Denmark Switzerland Iceland Japan Norway It makes a negative difference in these countries because prices of non-traded services in these countries are probably higher than they are in the US. Therefore, their purchasing power GDP is lower than GDP at the official exchange rate. You can see what is going on with the different exchange rates in the following equations: 1 1 vs PPP- US Foreign US Foreign GDP GDP GDP GDP e PPP = = Where e is the official exchange rate and PPP is the PPP exchange rate. As you can see, when the PPP is larger than e (due to higher prices) PPP-GDP is lower than GDP using the official exchange rate. 4. Identify the three countries with the largest percentage positive PPP adjustment. Name the countries and explain why the difference is large for these countries. Ghana, Dem. Rep. of Congo, Ethiopia. The difference is large for these countries because their prices of non-traded goods and services are much lower than in the USA since wages are much lower. As a result, the PPP exchange rate will be less than e, so PPPGDP will be greater than GDP at the official exchange rate. II. How long will it take to double GDPpc based on recent performance?
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