Purchasing Power Parity: When in India, Get a Haircut
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
📱 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
💡Purchasing Power Parity (PPP)
💡Tradeable goods
💡Services
💡Arbitrage
💡Labor
💡Immobile
💡Price level
💡GDP
💡Living standards
💡Currency
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.
Transcripts
♪ [music] ♪
♪ [Indian music] ♪
- [Alex] So today we're in India
to explain, and also to take advantage
of the Balassa-Samuelson effect.
We'll also be understanding a little bit more
about purchasing power parity corrections,
and why they're important.
So, let's take a look at this mobile phone store
and ask them about some prices.
Come on!
- [Alex] Namaste! [Hello!]
- [Shopkeeper] Namaste.
- [Alex] So, can you show me one of your nice phones?
- [Shopkeeper] Yeah. This is the best one --
the Apple -- the new one, the 7 Plus.
- [Alex] Great, great. Okay, that looks pretty good.
So, yeh kitne ka hai? [How much is this?]
- [Shopkeeper] Yah, 72,000. It's for 72,000.
- [Alex] Manga! [That's too much!]
- [Shopkeeper] Nahin, saste -- it's cheap now!
- [Alex] 70,000 rupees -- that's about 1,000 dollars --
at least as much, maybe a little bit more
than you'd pay in the United States.
And that makes sense,
because this good is easily tradeable.
Tradeable goods sell for about the same price
everywhere in the world.
Because if it were a lot cheaper here,
people would buy it here,
and sell it in the United States.
Arbitrage means that goods which are easily tradeable --
they sell for about the same price everywhere.
Now the situation, however, is very different
when it comes to services.
Services are hard to trade.
And that means that the price of services,
the price of labor --
it can differ a lot in different places in the world.
In fact, I think I need a haircut!
Let's go!
♪ [Indian music] ♪
- [Alex] Namaste! - [Barber] Hello, how are you, sir?
- [Alex] Good. Haircut today. - [Barber] Please come sit down.
- [Alex] Great.
- [Barber] Thik h sir. [It's fine sir.]
- [Alex] Achchha! [Good.] Yah.
Dhanyavaad. [Thank you.]
Well that was a good haircut,
and an excellent head massage.
And it cost me just 50 rupees.
That's less than a dollar in the United States.
Raju is just as good a barber as any in the United States,
but he earns a lot less.
Raju might like to come to the United States
and sell his labor for $10 an hour
instead of the $10 a day or less that he earns here in India.
But labor is immobile.
A host of laws prevent him from moving.
As a result, the price of labor can be very different
across the world,
and that means the price of services
that are immobile --
not just haircuts, but also housecleaning,
taxi services,
massage services --
they're a lot cheaper in poorer countries.
The fact that services are cheaper in poorer countries
is often called the Balassa-Samuelson effect,
after Béla Balassa and Paul Samuelson
pointed out this fact and developed models
to explain it at a deep level.
The fact that services are cheaper in poorer countries
also means that, on average, prices are lower --
the price level is lower.
That means that each dollar has greater purchasing power
in a poorer country.
And so if we want to compare GDP,
or if we want to compare living standards across countries,
we've got to take into account
the differences in purchasing power.
And that leads us to our next video
on purchasing power parity corrections.
Dhanyavaad. [Thank you.]
- [Narrator] You're on your way to mastering economics.
Make sure this video sticks by taking a few practice questions.
Or, if you're ready for more development economics,
click on the next video.
Still here?
Check out Marginal Revolution University's other popular videos.
♪ [music] ♪
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