Transcript The *law* of one price and purchasing power parity

Purchasing power parity
Y12 Economics - September 2016
Comparing GDP and Growth in GDP between
countries…..who’s winning?
• If GDP/Capita in US is $60,000 and GDP/Capita in Japan is ¥4,000,000
who is richer?
PPP – Purchasing Power Parity – sounds
complex buts its easy 
PPP measures how much you can buy of the same good in each country?
We use PPP to change GDP figures into US$ at an
exchange rate that takes account of purchasing power
$4.00
What Exchange Rates to compare GDP
between countries?
We use the costs of similar goods in Japan and USA to set the exchange
rate to compare GDP. Lets say we just use the price of Big Macs:
• A Big Mac costs ¥200 in Japan, $4 in USA.
• So the Purchasing Power Exchange Rate is ¥200/$4 = ¥50/$1 or ¥50 per $1
=
$4.00
Exercise to work out PPP exchange rate:
• An iPad in Japan costs ¥25,000
• An iPad in USA costs $500
• What is the Exchange Rate of
Japanese Yen to US Dollars based on
Purchasing Power Parity (PPP)?
• Find the PPP exchange rate by
DIVIDING the non-USD value (ie £, €,
¥ etc.) by the USD value.
Putting it all together:
1.
2.
3.
4.
5.
GDP per capita in Japan is ¥4,000,000 (Japanese Yen)
GDP per capita in US is $60,000 (US Dollars)
Who is better off? Lets convert the ¥4,000,000 to USD using PPP.
So convert ¥4,000,000 to $ at a rate of 50 to 1………
¥4,000,000/50 = $80,000
SO…..on a PPP measure, the average Japanese person enjoys $80,000
GDP/Capita
but the average US person enjoys just $60,000 GDP/Capita
Based on Purchasing Power, Japanese GDP/Capita is beating the USA
Its about finding a fair exchange rate
reflecting purchasing power…
• There are several baskets of identical goods set up in the classroom.
Go and find one and add up what it would cost in that countries
currency….
• Compare it to the USD basket and work out the PPP exchange rate
Now put the following GDP/Capita figures into
USD and order from biggest to smallest.
• ¥4,000,000 (Japan)
• A$100,000 (Australia)
• £35,000 (UK)
• $60,000 (USA)
• €55,000 (France)
For use in lesson
“Basket of Goods”
Market Exchange Rates are those used by Banks
and what you use when changing money when on
holiday.
Market Exchange Rates
$1 = £0.50
$1 = €1.00
$1 = ¥100
$1 = A$2.00