The theory of purchasing power parity (or PPP) holds that in the long run, the price of a particular basket of goods should adjust across countries and currencies to “cost” the same amount regardless of the currency the goods are denominated in. In other words, one dollar should buy the same amount of “stuff” in the US as it does in Mexico, China, the Netherlands or anywhere else in the world. If a dollar buys MORE in one of these countries once it’s been converted to the local currency, it implies that the local currency is undervalued and should adjust in the long run to achieve parity in the amount it can purchase in dollar terms.

One popular measure of purchasing power parity, devised by the folks at the Economist magazine’s intelligence unit, is the Big Mac Index, which measures the price of McDonald’s Big Macs in over 100 countries where they can be purchased. You can read more about this index here.

The Economist magazine recently reported on an new alternative to its own PPP index, “the Price of a Pint”:

"Barflies around the world provide a useful service for their beer-drinking comrades at PintPrice.com. The prices of pints of lager are compared on the basis of anecdotal evidence from beer-drinkers around the world, so figures are regularly updated. There are some surprising results. Beer in Zambia and Burundi seems eye-wateringly expensive considering that they are among the world’s poorest countries. The French overseas départments of Guadeloupe and Martinique charge just about as much as in mainland France. Beer-loving America and Britain fall somewhere in the middle. Happily for sports fans at the Beijing Olympics, a pint in China is just $2.46."

I thought it might be useful to some of our graduating seniors planning their summer vacations or gap years. Pay close attention to the data in this table.

(source: http://www.economist.com/displayStory.cfm?story_id=11333131)

So, if cheap beer is a priority in your vacation decision, it looks like North Korea and Myanmar are ideal destinations. I must say, I am relieved to see that Switzerland, my own new home, is not in the top ten… but it is far from cheap.

The website will tell you the average price of a pint of beer in any country in the world, and then break it down to cities within each country. In Zurich, my soon to be home, a pint costs the equivalent of $6.57 US. Compared to my hometown of Seattle, Washington, where a pint goes for $3.25, that’s exactly double the price! Surprisingly, however, a pint of beer here in Shanghai goes for a shocking $5.15, more than double the Chinese average of $2.35.

Apparently, the price of beer has more to do with the local supply and demand than with relative exchange rates. Where the Big Mac Index offers a rather genuine approach to determining purchasing power parity (since the Big Mac is an identical product sold by the same restaurant facing similar costs in over 100 countries), a pint of beer is a bit more subjective a measure of PPP. Quality of beers clearly differ in locales as diverse as North Korea and Luxembourg, not to mention the incomes of beer drinkers, the number of domestic brewers, excise and value added taxes, consumers’ price elasticities of demand, and so on.

As summer vacation approaches, however, vacation planners may care to take into account the “Price of a Pint” index of purchasing power parity. Clearly, one’s dollars will go much further at bars in some places than others.

I know what you 18 year old American high school grads are thinking, “Mexico or Canada?” You’ll just have to follow the link to find out!

(Disclaimer: Mr. Welker is in no way encouraging his former students to travel to certain places based solely on the cheap price of beer there, merely to avoid places where beer is clearly out of their price range ! )

Source: http://welkerswikinomics.com/blog/2008/06/01/purchasing-power-parity-for-the-inebriated-masses/

Excerpt from Welker’s Wikinomics Blog : http://welkerswikinomics.com/blog/2008/04/10/loanable-funds-vs-money-market-whats-the-difference/

Two markets for money, right? Yes… so do they show the same thing? NO! You must know the distinction between these two markets. First let’s talk about the Money Market diagram.

This market refers to the Money Supply (M1 and M2). The Money Supply curve is vertical because it is determined by the Fed’s (or central bank’s) particular monetary policy. On the X axis is the Quantity of money supplied and demanded, and on the Y axis is the nominal interest rate. This is the nominal rate because it is determined by the Fed as it shifts the Money Supply in or out (tight money or easy money). A tight monetary policy (selling of bonds by the Fed) will shift Money Supply in, raising the federal funds rate, and subsequently the interest rates commercial banks charge their best customers (prime interest rate). These are nominal rates. On the other hand, an easy money policy (buying of bonds by the Fed) shifts Sm out, lowering the Federal Funds rate and thus the prime interest rate.

You should also know why a tight money policy is considered contractionary and why an easy money policy is considered expansionary monetary policy. Higher nominal interest rates resulting from tight money policy will discourage investment and consumption, contracting aggregate demand. On the other hand, an easy money policy will encourage more investment and consumption as nominal rates fall, expanding aggregate demand.

Government deficit spending and the money market: Does an increase in government spending without a corresponding increase in taxes affect the money market? You may be inclined to say yes, since the Treasury must issue new bonds to finance deficit spending. After all, when the Fed sells bonds, money is taken out of circulation and held by the Fed, thus it’s no longer part of the money supply.

When the Treasury issues and sells new bonds, however, the money the public uses to buy the bonds is put back into circulation as the government spending is increased. Therefore, any leftward shift of the money supply curve caused by the buying of bonds by the public is offset by the injection of cash in the economy initiated the government’s fiscal stimulus package takes effect (be it a tax rebate or an increase in spending). Therefore, money supply should remain stable when the government deficit spends.

Now to the loanable funds market. Loanable funds represents the money in commercial banks and lending institutions that is available to lend out to firms and households to finance expenditures (investment or consumption). The Y-axis represents the real interest rate; the loanable funds market therefore recognizes the relationships between real returns on savings and real price of borrowing with the public’s willingness to save and borrow.

Since an increase in the real interest rate makes households and firms want to place more money in the bank (and more money in the bank means more money to loan out), there is a direct relationship between real interest rate and Supply of Loanable Funds. On the other hand, since at lower real interest rates households and firms will be less inclined to save and more inclined to borrow and spend, the Demand for loanable funds reflects an inverse relationship. At higher interest rates, households prefer to delay their spending and put their money in savings, since the opportunity cost of spending now rises with the real interest rate.

Government deficit spending and the loanable funds market: We learned above that only the Fed can shift the money supply curve, but what factors can affect the Supply and Demand curves for loanable funds? Here’s a few key points to know about the loanable funds market.

• When the government deficit spends (G>tax revenue), it must borrow from the public by issuing bonds.
• The Treasury issues new bonds, which shifts the supply of bonds out, lowering their prices and raising the interest rates on bonds.
• In response to higher interest rates on bonds, investors will transfer their money out of banks and other institutions and into the bond market. Banks will also lend out fewer of their excess reserves, and put some of those reserves into the bond market as well, where it is secure and now earns relatively higher interest.
• As households, firms and banks buy the newly issued Treasury securities, the supply of loanable funds shifts in, driving up the real interest rate and leading to a movement along the demand curve for loanable funds.
• This causes crowding out of private investment.

Another, simpler way to understand the effect of government deficit spending on real interest rates is to look at it from the demand side.

• Deficit spending by the government requires the government to borrow from the public, increasing the demand for loanable funds. In essence, the government becomes a borrower in the country’s financial sector, demanding new funds for investment, driving up real interest rates.
• The combination of a decrease in supply of loanable fund due to the public’s purchase of bonds and the increase in demand due to the government’s need to borrow to finance its expenditures drives real interest rates up.
• This leads to the crowding out effect, in which private investors face higher real interest rates due to increased deficit spending by the government.
• A decrease in private investment resulting from the higher real interest rates will “crowd-out” the intended increase in overall spending the government hoped for when implementing expansionary fiscal policy in the first place, as can be seen by the dotted line in the graph on the right.

What could shift the supply of loanable funds to the right? Easy, anything that increases savings by households and firms. Remember from Chapter 8 the determinants of consumption and saving? These include wealth, expectations, and taxation. If savings increases, Supply of loanable funds shifts outward, lowering real interest rates, encouraging firms to undertake new investments. This is why many economists say that “savings is investment”. What they mean is increased supply of loanable funds, itself leading to lower interest rates and increased investment.

On the other hand, an increase in demand for investment funds by firms will shift demand for loanable funds out, driving up real interest rates. The determinants of investment include business taxes, technological change, expectations of future business opportunities, and so on (follow link to our wiki page on Investment).