Purchasing Power Parity: When in India, Get a Haircut

Marginal Revolution University

5 Sept 201704:27

Summary

TLDRIn 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.

Outlines

00:00

📱 Understanding the Balassa-Samuelson Effect

In this paragraph, Alex is in India exploring the Balassa-Samuelson effect and purchasing power parity corrections. He visits a mobile phone store to compare prices of an Apple 7 Plus, noting that it costs 70,000 rupees (around $1,000), similar to the price in the United States. This illustrates the concept of tradeable goods, which are subject to arbitrage and tend to have similar prices globally. Alex then contrasts this with services, which are harder to trade and can vary significantly in price across different countries.

💈 Services and Labor Prices in Different Economies

Alex gets a haircut in India for just 50 rupees, which is less than a dollar, highlighting the difference in labor and service costs between countries. He explains that labor is immobile due to various laws and regulations, leading to significant differences in the price of services like haircuts, housecleaning, and taxi services in poorer countries. This phenomenon, known as the Balassa-Samuelson effect, was identified by Béla Balassa and Paul Samuelson and suggests that prices are generally lower in poorer countries, increasing the purchasing power of each dollar.

🌐 Comparing GDP and Living Standards Across Countries

The paragraph concludes with Alex discussing the importance of considering purchasing power when comparing GDP and living standards across different countries. He suggests that the next video will delve into purchasing power parity corrections, which are essential for accurate economic comparisons. The narrator encourages viewers to practice what they've learned and explore more development economics through additional videos.

Mindmap

Keywords

💡Balassa-Samuelson effect

The Balassa-Samuelson effect refers to the phenomenon where the price level of non-tradable goods and services is higher in countries with higher per capita income. In the video, this effect is illustrated by the lower cost of services like haircuts in India compared to the United States, which is a country with a higher per capita income.

💡Purchasing Power Parity (PPP)

Purchasing Power Parity is an economic theory that compares different countries' currencies through a 'basket of goods' to determine the relative value of those currencies. The video discusses PPP corrections as a way to compare GDP or living standards across countries by accounting for differences in the cost of living.

💡Tradeable goods

Tradeable goods are items that can be bought and sold across international borders. The video explains that these goods tend to have similar prices worldwide due to arbitrage, using the example of an Apple iPhone 7 Plus being similarly priced in India and the United States.

💡Services

Services are intangible products that are not easily tradable across borders due to factors like location and the need for personal interaction. The video contrasts tradeable goods with services, noting that services like haircuts are cheaper in India, illustrating the Balassa-Samuelson effect.

💡Arbitrage

Arbitrage is the practice of taking advantage of price differences for identical or equivalent financial instruments, commodities, or cash flows. The video uses arbitrage to explain why tradeable goods like the Apple iPhone are priced similarly across countries.

💡Labor

Labor refers to the work done by humans, often in exchange for wages or other forms of compensation. The video discusses labor as an immobile factor of production, contrasting it with the ease of trade for goods, and uses the example of a barber in India earning less than his U.S. counterpart.

💡Immobile

Immobile, in the context of the video, refers to factors that cannot easily move from one location to another, such as labor and certain services. This immobility contributes to the differences in the cost of services and labor across countries.

💡Price level

Price level refers to the average price of goods and services in an economy. The video explains that the price level is lower in poorer countries, which means that each unit of currency has greater purchasing power there.

💡GDP

Gross Domestic Product (GDP) is the total value of goods and services produced in a country over a specific period. The video mentions comparing GDP across countries and the importance of adjusting for purchasing power differences to get accurate comparisons.

💡Living standards

Living standards refer to the level of wealth, comfort, and material welfare available to people in a country. The video discusses how differences in purchasing power can affect the comparison of living standards across countries.

💡Currency

Currency is a generally accepted form of money, including coins and paper notes, which is issued by a government and circulated within an economy. The video touches on currencies in the context of comparing purchasing power across different countries.

Highlights

Introduction to the Balassa-Samuelson effect and its significance in economics.

Explanation of purchasing power parity corrections and their importance.

Observation of the price of an Apple iPhone 7 Plus in India compared to the United States.

Discussion on the concept of arbitrage and its role in pricing tradeable goods.

Comparison of the price of services, such as haircuts, in India versus the United States.

Explanation of why labor is considered immobile and its economic implications.

Description of the economic situation of a barber named Raju in India.

The economic concept of the Balassa-Samuelson effect and its originators.

Impact of the Balassa-Samuelson effect on the average price level and purchasing power.

The necessity of considering purchasing power when comparing GDP or living standards across countries.

Introduction to the next topic: purchasing power parity corrections.

Encouragement for viewers to engage with practice questions to solidify their understanding.

Invitation for viewers to explore more development economics content.

Mention of Marginal Revolution University's other popular videos for further learning.

The transcript concludes with a motivational message to viewers on their journey to mastering economics.