Purchasing Power of Parity

1
Purchasing Power of Parity

• What does 2 buy?

2
Living on 2 a day

• Nearly half the worlds population lives on less
  than 2 a day.
• Note we will refer to the sign as US Dollars
• What does this mean? That is, what does 2 buy
  you?
• To better comprehend what this means, well use
  Mumbai India as an example.
• Nearly 75 of the population in Mumbai, India
  lives on less than 2 a day.

3
What can you buy with your Rupees?

• Suppose you live in Mumbai, India.
• Additionally, you are told that you earn 92
  Indian Rupees per day.

4
How do we interpret 92 Rupees?

• What does this salary mean to you?
• Probably not much. Why?
• How much goods services does 92 Indian Rupees
  buy you?

5
Purchasing Power of Parity Nominal Exchange
Rates

• As it turns out, 92 Rupees is equivalent to 2 US
  dollars.
• As of August 6th, 2010
• But thats not the end of the story
• What we have done is a simple nominal exchange
  rate.
• What we need is a purchasing power of parity
  index to better understand what 2 or 92 Rupees
  buys us in Mumbai India.

6
Purchasing Power of Parity (PPP) Index

• A purchasing power of parity index helps us to
  compare the cost of a typical basket of goods and
  services we consume to the cost of that basket
  in a different country.
• For example A 3-mile/5km taxi ride
• In New York 10.25
• In Mumbai India 1.37

7
Relative Purchasing Power

• Why is a taxi ride so much cheaper in India vs.
  New York?
• Without getting too far off-track, part of the
  reason is that services tend to be cheaper in
  countries that are labor abundant relative to
  capital abundant countries.
• So far weve just looked at taxi rides. Suppose
  we examine a more diverse basket of goods and
  services.

8
Price comparison of a typical basket of Western
goods/services.

• Using a weighted basket of 122 goods and
  services.
• Whats meant by weighted?
• Well, suppose you spend 40 of your income on
  housing and 5 on electronics.
• Therefore, prices of housing will affect you more
  than electronics and a weighted basket accounts
  for this.

9
What does a typical monthly basket cost?

• Using a basket of 122 goods services
• New York 2,969
• Mumbai, India 916
• It looks much cheaper to live in Mumbai India
  than New York. In fact, its about 31 cheaper
  and if you could take your 2,969 spent on goods
  services over to Mumbai, you could purchase
  much more.

10
Heres the Catch

• Remember that 75 of the population in India
  lives on less than 2 a day - That is, less than
  60 per month.
• In other words, 75 of the population in Mumbai
  India lives on what you could buy for 194 per
  month in New York!
• (60/916) x 2,969 194

11
The cost of a food basket per month.

• Food Prices
• New York 571
• Mumbai, India 153
• Again, it looks cheaper in Mumbai India.
• However, 75 of people living in Mumbai on 2 a
  day could spend their entire income on food and
  still only have 40 of the daily food intake
  compared to that of a typical individual in New
  York
• (60 / 153)x100 40.
• To put this in a relative perspective This would
  be equivalent to someone living in New York,
  spending their entire income on just food (no
  housing, clothing, entertainment etc.) and still
  just be able to consume 40 of the amount of food
  that the average New Yorker lives on.
• (60/153) x 571 224

12
Why do workers in developing nations earn so much
less than those in developed nations?

• Productivity Output
• The value of output per hour per worker.
• There are many factors that contribute to
  productivity.
• Physical Capital
• Human Capital
• Technology
• There are also many reasons as to why these
  factors are lacking in developing nations.

13
When workers become more productive, the higher
the value of their output per hour worked and
subsequently, the wages that they can command.

• Average minutes of work required to buy
• 1 Kg of Rice
• New York 8 minutes
• Mumbai India 37 minutes
• 4.6 the amount of time in Mumbai relative to New
  York.
• An individual in Mumbai must work almost 5 times
  longer to buy a kg. of rice vs. someone in New
  York.
• 1 ipod Nano (8 GB)
• New York 9 hours
• Mumbai India 177 hours
• 19.6 the amount of time in Mumbai relative to New
  York.

14
How can we help to improve productivity thus
wages?

• Adding more Physical Capital
• Your fundraising efforts during the 2 a day
  challenge can help those in developing nations
  obtain a loan.
• These loans can be used to buy new equipment for
  an entrepreneur's business.
• This new equipment can make the business more
  productive.

15
Improving Skills

• Adding more Human Capital (knowledge)
• The equipment that is purchased may also be
  operated by an employee, improving on-the-job
  skills.
• These skills can be taught and used by the
  employee elsewhere making him or her more
  productive.

16
Example The Shirt Maker

• Suppose you live in Mumbai India and make shirts
  for a living.
• To make a shirt, you must buy cloth, and using a
  needle and thread, sew together the shirt.
• For simplicity, well assume this process takes
  you 1-hour.
• That is, you make 1 shirt an hour

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How can Physical Capital help the shirt maker?

• Suppose that you apply for a loan to purchase a
  sewing machine.
• With the sewing machine, you can now make 2
  shirts per hour.
• Therefore, the value of your output per hour
  worked has doubled!

18
How can Human Capital help the shirt maker?

• Given that you are now twice as productive as
  before, you can maintain the same standard of
  living by allocating half the amount of time to
  work as before.
• With this extra time, you decide to learn how to
  silkscreen.
• The silkscreen process will allow you to add
  designs and colors to your shirts.
• This improvement in knowledge makes the value of
  your output per hour worked even greater.

19
The Shirt Makers Standard of Living.

• Remember that we said an individual in Mumbai,
  must work 5 times longer than an individual in
  New York to buy the same kg. of rice.
• After the improvement in both Physical Capital
  and Human Capital, the individual in Mumbai can
  now consume more goods (rice in our case)
  working the same amount of hours.

20
So where do you come in?

• By participating in The Two Dollar Challenge,
  youre helping create awareness about global
  poverty and the challenges faced.
• Through fundraising efforts, youre helping to
  grow the level of physical and human capital
  available to those in developing nations.