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Unformatted text preview: Macroeconomic Policy Class Notes Long run growth 1: facts and possibilities Revised: October 3, 2011 Latest version available at www.fperri.net/teaching/macropolicyf11.htm In the next few classes we will try to understand long run economic growth. Our focus will be both on long run variation of GDP (per capita) across time and across countries. International Comparisons and PPP exchange rate How do we compare per capita GDP in two different countries, since it is expressed in two different currencies? One possibility is to use the market exchange rate. Some times though this method can be misleading, especially if GDP is meant to capture standards of living. For example in 2009 GDP per capita in China was around Y25500, while in US was around $46400. If we use the market exchange rate (6.8 Yuan, or Renmimbi per 1 dollar) to compare the two levels we find that GDP per capita in China is about 25500/6.8=$3700, i.e. GDP per capita in US is about 12 times GDP per capita in China. In reality 6.8 Yuan in China have more purchasing power that 1 dollar in the US so that figure overstates the differences between standards of living US and China. A better way of comparing the two figures is obtained by using the PPP exchange rate is the exchange rate that equalize the purchasing power of the two currencies in each of the two countries. To compute the PPP exchange rate one needs to measure the cost of the typical basket of goods and services consumed in US ( P US ) and in China ( P China ) and then find the exchange rate that equalize these costs across countries. So the Dollar Yuan PPP exchange rate (denoted as e PPP ) is given by e PPP = P US P China In 2009 the PPP exchange rate is around 3.6 Yuan per dollar (Reflecting the fact that 3.6 Yuan in China get you the same amount of goods and services that you get Facts and possibilities 2 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 198019821984198619881990199219941996199820002002200420062008 Ratio to US PPP exchange rate Market exchange rate Figure 1: GDP per capita: China relative to US in US with 1 dollar). If one uses this exchange rate then GDP per capita in China is around 25500/3.6=7000 i.e. US is about 7 times as rich as China. Figure 1 plots the GDP per capita of China relative to the US using the market rate and the PPP rate. Note that only the two series are remarkably different both in terms of level and of growth rates. When making international comparisons of GDP is more appropriate to use a PPP exchange rate and from now on all our international data will be based on PPP exchange rates. Facts and possibilities 3 The Big Mac index A special example of PPP exchange rate is given by the exchange rate that equalizes the costs of BigMacs. If for example the price of a BigMac is $2 in US and 4 Euros in Europe the exchange rate that equalizes the cost of the two is 2 Euros per dollars. For more details check the link to the economist site Big Mac index and see below the Big Mac index in July 2010. Obviously PPPand see below the Big Mac index in July 2010....
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 Spring '08
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 Macroeconomics

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