Purchasing Power Parity: When in India, Get a Haircut

Summary

In this video, Alex explores the Balassa-Samuelson effect while visiting India. He compares prices of tradeable goods, like mobile phones, which are similarly priced globally due to arbitrage, with non-tradeable services, such as haircuts, which are significantly cheaper in poorer countries. The difference is attributed to labor immobility, which prevents services from being sold across borders. This results in lower service costs and a higher purchasing power in these countries. The video introduces the importance of purchasing power parity (PPP) corrections when comparing GDP and living standards across nations.

Takeaways

• 🌏 The Balassa-Samuelson effect explains why services are cheaper in poorer countries.
• 📱 Tradeable goods like the Apple iPhone 7 Plus tend to have similar prices worldwide due to arbitrage.
• 💈 Services such as haircuts are cheaper in India because labor is immobile and laws prevent easy movement across borders.
• 💼 Labor mobility is restricted by laws, which results in varying labor costs and service prices globally.
• 💸 The price of services, including non-tradable ones like housecleaning and taxi services, is significantly lower in poorer countries.
• 📉 The lower price level in poorer countries means each unit of currency has greater purchasing power.
• 📊 To accurately compare GDP or living standards across countries, purchasing power parity (PPP) corrections are necessary.
• 🧳 Arbitrage ensures that easily tradable goods sell for approximately the same price everywhere to prevent profiteering from price differences.
• 🌉 The difference in service prices highlights economic disparities and the impact of globalization on local economies.
• 🔍 Understanding the Balassa-Samuelson effect is crucial for economists analyzing international trade and economic development.

Q & A

What is the Balassa-Samuelson effect mentioned in the script?

The Balassa-Samuelson effect refers to the phenomenon where the price of non-tradable goods, particularly services, tends to be lower in countries with lower per capita incomes. This effect is named after Béla Balassa and Paul Samuelson, who pointed out this fact and developed models to explain it.

Why are services cheaper in poorer countries according to the script?

Services are cheaper in poorer countries because labor is immobile and subject to a host of laws that prevent it from moving to places where it could be sold at a higher price. As a result, the price of services, including haircuts, housecleaning, taxi services, and massage services, is lower.

What does the script imply about the purchasing power of a dollar in a poorer country?

The script implies that each dollar has greater purchasing power in a poorer country because the price level is lower due to cheaper services and non-tradable goods.

Why is it important to consider purchasing power parity when comparing GDP or living standards across countries?

It is important to consider purchasing power parity (PPP) because nominal exchange rates can overstate or understate the true value of goods and services across countries. PPP adjustments provide a more accurate measure of economic output and living standards by accounting for differences in the cost of living.

What is arbitrage as explained in the script?

Arbitrage, as explained in the script, is the practice of taking advantage of price differences in different markets to make a profit. It ensures that easily tradable goods sell for about the same price everywhere in the world because if they were cheaper in one place, people would buy them there and sell them in more expensive markets.

How does the script illustrate the concept of tradeable goods?

The script illustrates the concept of tradeable goods by discussing the price of an Apple iPhone 7 Plus in India, which is similar to the price in the United States. This similarity indicates that tradeable goods, being easily bought and sold across borders, tend to have similar prices worldwide.

What is the difference between tradable and non-tradable goods as per the script?

Tradable goods, as per the script, are easily bought and sold across borders, such as electronics and mobile phones, and tend to have similar prices worldwide due to arbitrage. Non-tradable goods, like services, are harder to trade and can have significantly different prices in different countries.

Why does the script mention that labor is immobile?

The script mentions that labor is immobile to highlight that laws and regulations often prevent workers from moving to countries where they could earn more. This immobility contributes to the Balassa-Samuelson effect by keeping the price of services and labor lower in poorer countries.

What is the significance of the price of a haircut in India as discussed in the script?

The price of a haircut in India, which is significantly lower than in the United States, serves as an example of the Balassa-Samuelson effect. It demonstrates how services, being non-tradable, can have vastly different prices in countries with different levels of economic development.

How does the script suggest that one can enhance their understanding of economics?

The script suggests that one can enhance their understanding of economics by watching videos, taking practice questions, and exploring more development economics content, as offered by Marginal Revolution University.