Economics Lecture: The Balassa-Samuelson Effect and Purchasing Power Parity

Introduction

• Location: India
• Topic: Understanding the Balassa-Samuelson Effect and Purchasing Power Parity (PPP) corrections

Pricing of Goods and Services

Tradeable Goods

• Example: Mobile phones
• Observation: Prices of tradeable goods like the Apple 7 Plus are similar worldwide (e.g., 72,000 rupees or ~$1,000).
• Reason: Arbitrage ensures that easily tradeable goods sell for about the same price globally.
  • If goods were cheaper in one location, they would be bought there and sold in more expensive markets.

Non-Tradeable Services

• Example: Haircuts
• Observation: Price of services can vary significantly between countries.
  • Haircut in India cost 50 rupees (less than $1), much cheaper than in the US.
• Reason: Services are hard to trade and labor is immobile.
  • Legal and logistical barriers prevent labor from moving freely.

Balassa-Samuelson Effect

• Definition: The phenomenon where services are cheaper in poorer countries.
• Contributors: Named after economists Béla Balassa and Paul Samuelson.
• Explanation:
  • Labor costs are lower in poorer countries due to immobility.
  • This results in lower prices for non-tradeable services like haircuts, housecleaning, taxi services, and massages.
• Implication:
  • Overall, prices (price levels) are lower in poorer countries, meaning each dollar has more purchasing power.

Importance of Purchasing Power Parity (PPP)

• Purpose: To compare GDP and living standards across countries accurately.
• Need for PPP: It adjusts for differences in price levels across countries, reflecting real purchasing power.

Conclusion

• Recommendation: View the next video on purchasing power parity corrections for further explanation.
• Additional Learning: Practice questions available to reinforce understanding.