Role of Non traded goods Balassa Samuelson Theory Theory by Bhagwati Kravis and

Role of non traded goods balassa samuelson theory

This preview shows page 55 - 66 out of 88 pages.

Role of Non traded goods Balassa-Samuelson Theory Theory by Bhagwati, Kravis, and Lipsey.
Image of page 55
Explaining the Problems with PPP (cont.) Balassa-Samuelson Theory Why? Differential productivity in countries Labor is less productive in poor countries in the t radables( e.g. manufacturing goods ), but not in th e non-tradables ( e.g. services ). If the prices of traded goods are roughly equal in all countries Lower labor productivity in the tradable implies lower wages in both tradable and non-tradable se ctor, and lower production costs in non-tradables .
Image of page 56
Explaining the Problems with PPP (cont.) Balassa-Samuelson Theory One of Critiques: source of the price differential depends on only supply side. (De Gregorio, Giov anni and Wolf, EER , 1994)-variations in aggregat e demand, like changes in Income, wealth and pu blic expenditure are an important determinant of relative price variations.
Image of page 57
Explaining the Problems with PPP (cont.) Theory by Bhagwati, Kravis, and Lipsey Why? Differences in endowments of capital and labor It also predicts that the relative price of non-tradables rises as real per captia income increases. Poor country tends to have low capital-labor ratio. Marginal productivity of labor is lower in poor countries, s o lower wage level. Non-tradables are naturally labor-intensive. Because labor is cheaper in poor countries and is used intensively in non- tradables, non-tradables are also cheaper. Overall price lev els should be lower if measured in one currency.
Image of page 58
Beyond Purchasing Power Parity -Real Exchange Rate Why do we still talk about PPP in spite of the f ailure of empirical supports? Its basic idea of relating long-run exchange rat es to long-run national price levels is a very us eful starting point. We can generalize the simple monetary approa ch by taking into account of some of the reaso ns why PPP predicts badly in practice.
Image of page 59
Beyond Purchasing Power Parity -Real Exchange Rate The major prediction of PPP is that real exchang e rates never change, at least not permanently. As the first step in extending the PPP theory, we need to examine the forces that can cause dramat ic and permanent changes in real exchange rates.
Image of page 60
Beyond Purchasing Power Parity -Real Exchange Rate Nominal exchange rate relative price of two currencies Real exchange rate relative price of two output baskets
Image of page 61
Beyond Purchasing Power Parity -Real Exchange Rate
Image of page 62
Beyond Purchasing Power Parity -Real Exchange Rate
Image of page 63
Beyond Purchasing Power Parity -Real Exchange Rate If the EU basket costs €100, the US basket costs $12 0 and the nominal exchange rate is $1.20 per euro, the n the real exchange rate is 1 US basket per EU bas ket . If the EU basket costs €100, the US basket costs $10 0 and the nominal exchange rate is $1.20 per euro, the n the real exchange rate is 1.2 US basket per EU ba sket . A real depreciation of the value of US products.
Image of page 64
Beyond Purchasing Power Parity -Real Exchange Rate A depreciation of US real exchange rate.
Image of page 65
Image of page 66

You've reached the end of your free preview.

Want to read all 88 pages?

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture