Purchasing power parity

by on February 12, 2007 at 7:49 am in Economics | Permalink

Purchasing power parity is:

1. A tautology.

2. An equilibrium condition, satisfied by any good theory of exchange rates.

3. Itself a theory of exchange rates.

4. An outer bound which good theories of exchange rates may not violate.

5. Holds only for individual goods of homogeneous nature.

6. Holds only for price indices of tradeables.

7. Totally false.

8. All of the above.

Esoceicy!  Correct answers will be given a free dining room set.

1 nelsonal February 12, 2007 at 8:23 am

The inspiration for the best table in the Economist.

2 Mike N February 12, 2007 at 8:35 am

3 and 6 are the closest I think. I would also accept 7 because I think true PPP takes into account the local level of income. That’s why it is cheaper (at current exchange rates) to buy a good meal in Anderson, SC than it is in New York City, and cheaper still in Poland or India.

3 Derek Lowe February 12, 2007 at 9:25 am

Tyler, I won a dining room set when I was on “Jeopardy” years ago. I had no room for it, no particular liking for its style, and little hope of being able to store it and subsequently sell it. And, naturally, I would owe taxes on it in the meantime. I ended up turning the prize down, as I think a lot of people do. Don’t inflict another one on me. . .

4 Tyler Cowen February 12, 2007 at 10:21 am

Alex sent me a query, here was my response:

I’ve been waiting for someone to ask…

“Esoceicy n. Obsession or preoccupation with the little things.”

Of course poking fun at the notion that a) to most people it does seem like a little thing, b) it really isn’t little at all, hardly anyone understands a very fundamental theory!

But that is only in an on-line Dictionary of Nonsense Words, it doesn’t seem to be a real word at all, which heightens the Borges-like use of the term and the reference to the unreality of PPP. There are other aspects of the reference, too.

But of course only the most loyal of MR readers will get those jokes.

5 josh February 12, 2007 at 10:49 am

1,2 and 3 all seem correct to me.

6 GVV February 12, 2007 at 11:04 am

Well, if the offer is inclusive of shipping costs, then the answer is no:2.

7 eriks February 12, 2007 at 11:44 am

Esoceicy embiggens even the smallest man or woman.

Probably 3 & 7 but I’m not an expert.

8 kevin February 12, 2007 at 12:24 pm

is so ez indeed. eggsactly. its #8, all of the above (though none of the above would also be accepted for full credit). give the dining room set to Pete Boettke for me.

9 younotsneaky February 12, 2007 at 2:48 pm

3, with a “depends what you mean” on 4 and then a couple “maybies”

9. Not a bad guide, at least in its relative version, to what happens in the long run

10 DK February 12, 2007 at 3:55 pm

yes, anon, which is why i said “implicit tax or …”. If your simple economy doesn’t include other regulatory costs, lawsuits, shortages of nearby workers due to rent control, etc., then yes it does disappear into ground rent.

and yes, josh, I’m with #1, tautology, but it seemed redundant to actually spell that out. #5 and maybe #4 are also appealing.

11 Martin February 12, 2007 at 4:39 pm

(3) is correct.

(1) is false because PPP is falsifiable.
(2) and (4) are false because PPP does not always hold in the data,
and you do not define what is meand by good.
(5), (6), and (7) are false because although the real exchange rate is
highly volatile, it is (likely) mean reverting even when computed
from the CPIs (which includes differentiated products and
(8) is false because tautologies are not falsifiable.

12 MattXIV February 12, 2007 at 6:45 pm

3. Yes, since it does include implications for equilibrium exchange rates.

4. Yes, if that means that with the right simplifing assumptions in your equilibrium case you should get PPP.

5. Yes, since the theoretical explaination stems from the assumption of a single price for an individual homogenous good.

6. No, since it’s only applicable to the index if applicable to the goods within the index. Indices help by averaging out short term variation, but don’t have any theoretical significance.

13 ricardo February 12, 2007 at 9:41 pm

2, 5 and 7.

14 Jack February 13, 2007 at 2:39 am

9. A way of allowing Americans to think that their economy is growing rapidly.

15 Andrew Edwards February 14, 2007 at 12:14 am

10. A pretty theory in no way supported by the data, only reasonable if proposed in the complete absence of data, and thus a lynchpin of both the style and content of most macroeconomic thought.

16 Francis February 14, 2007 at 2:54 am

As a not-economist, I would answer 9, a way of forcing an international economist into thinking about the pricing of non-tradable goods.

most people start their day worrying about shelter, food, water and basic utilities. Big Macs come later. so do aircraft carriers. as does better welfare benefits.

in the ’70s, my dad used to say that it was very expensive to live as an American in Japan, but much more affordable to live as a Japanese. what should NY law firms pay its associates stationed in Japan?

one answer is “enough to get the ones you want there willing to go”. but i suspect that there were a number of factors figured into the decision for a NY associate to practice law in Japan. One is “can I save as much as I was saving in the US while having a relatively comparable lifestyle”. Other factors include improved chances of making partner, a willingness for adventure and surely some others i’m not thinking of at midnight.

17 Justin Lawler February 26, 2007 at 6:27 am

Does PPP work in the case of something like Electricity pricing? Surely the price of the inputs (ie.Energy) is dictated by the global demand. As this is the main cost involved in the production and labour is a minor compontent the only difference between countries should be dictated by the capital costs of the infrastructure. And that is increasingly globalised as well as large companies like Siemens etc build power stations all over the world.

I would like to know as I am having this argument with some collegues that there is no justification for electricity prices in Ireland to be higher than in other parts of the EU (25% above the average), we all burn the same oil, gas and coal at the end of the day. With the qulifier of course that some countries have a bias to different forms of generation e.g. France and Nuclear.

Thanks if you can settle the argument (but then again is any economics argument settled)



18 jad games February 9, 2010 at 1:18 pm

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