Therefore we need a new measure that allows for a

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Unformatted text preview: GDPs are not immediately comparable. ì༎  This means it is necessary to put different GDPs into comparable terms. The most obvious way to do this is to use the exchange rate. ì༎  This process has some intui1ve problems. ì༎  Lets say the US- Indian exchange rate is 45 rupees per dollar. ì༎  Indian GDP per capita is 21,150 rupees which is $470 ì༎  The problem is anyone who has been in a developing country knows that a dollar goes further in those countries. Exchange- Rate Conversion Problems ì༎  Consider, for example, the price of haircut. ì༎  In Mumbai a haircut costs 180 rupees ($4 at the official exchange rate). ì༎  In Boston a basic haircut may cost $40 ì༎  A dollar can purchase more in Mumbai than Boston. ì༎  Therefore we need a new measure that allows for a beCer comparison of GDP. Exchange- Rate Conversion Problems ì༎  Why doesn’t the exchange rate fully capture the GDP in developing countries? ì༎  The answer lies in the fact that the prices of goods may not be the same across countries. ì༎  Many of you probably learned in your Macro classes about something called arbitrage (the prac1ce of buying a good cheaply in one market and selling it for a higher price in another). ì༎  But arbitrage can only occur if the goods can be traded interna1onally. ì༎  Goods like haircuts, transporta1on, land, educa1on, etc cannot be exported therefore their prices can differ across countries. Purchasing Power Parity (PPP) ì༎  Purchasing Power Parity, like the exchange rate, allows us to compare GDP across countries. ì༎  However, it takes into account that some goods are not traded and therefore alters the GDP figures accordingly. ì༎  To calculate the PPP a basket of goods that are shared across countries (not without difficul1es) and calculate the price using a fixed currency (the PPP dollar). Purchasing Power Parity (PPP) Exchange Rate versus PPP India United States Quan4ty Price ($) Value of Output ($) Quan4ty Price (Rupees) Value of Output (Rupees) Steel 100 200 per ton 20,000 8 9,000 per ton 72,000 Retail Sales Personnel 2 5,000 per person 10,000 4 60,000 per year 240,000 Total GDP 30,000 Based on steel prices, official exchange rate is 9000/200 or Rs45=1. 312,000 Purchasing P...
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