Why can market exchange rates mislead when comparing incomes?

An exchange rate reflects the currencies actually traded internationally. Prices of goods that are not traded, such as housing and local services, are far lower in poorer countries. Converting at the market rate therefore understates what an income actually buys.

What is purchasing power parity?

Purchasing power parity is an exchange rate at which a given basket of goods costs the same in two countries. Incomes converted at that rate are comparable in terms of what they buy.

How does a purchasing power parity adjustment change the picture?

Incomes in poorer countries rise substantially relative to richer ones once the adjustment is made. The measured gap between rich and poor economies narrows, though it remains large.

What is the Big Mac index?

The Big Mac index compares the price of a single standardised product across countries. The comparison gives an accessible illustration of purchasing power parity, though one product is far too narrow a basket for serious use.

Eduqas A-Level Economics A520QS

Scarcity, Choice and the Economic Problem

Topic overview Scarcity, choice and the basic economic problem The factors of production and their rewards Opportunity cost for individuals, firms and government Economic goods, free goods and the three fundamental questions The production possibility frontier and its shape Movements along and shifts in the frontier Efficiency, unemployed resources and the frontier Specialisation, the division of labour and exchange Productivity and how it is raised

Demand, Supply and Market Equilibrium

Topic overview Product markets and the objectives of economic agents Marginal utility and the derivation of demand The demand curve and why it slopes downward The conditions of demand and shifts in the demand curve Supply and why the supply curve slopes upward The conditions of supply and shifts in the supply curve Equilibrium price and output in a competitive market Shifts in demand and supply and the new equilibrium Consumer surplus, producer surplus and market welfare

Elasticities of Demand and Supply

Topic overview Price elasticity of demand and its calculation What determines price elasticity of demand Price elasticity of demand and total revenue Elasticity along a straight-line demand curve Income elasticity of demand, normal and inferior goods Cross price elasticity of demand, substitutes and complements Price elasticity of supply and its determinants Elasticity and the incidence of taxes and subsidies Elasticity in decision-making by firms and government

The Labour Market

Topic overview The demand for labour and what shifts it The supply of labour and what shifts it Wage determination in a competitive labour market The elasticity of demand and supply of labour Wage differentials and their causes Labour market flexibility and trade union power Welfare payments, income tax and labour market performance The national minimum wage Migration and the labour market

Costs, Revenues, Profits and the Growth of Firms

Topic overview Prices, profit and the allocation of resources The short run, the long run and diminishing returns Total, average and marginal product Fixed and variable costs in the short run Average and marginal cost curves and their shapes Total, average and marginal revenue Economies and diseconomies of scale and the long run average cost curve Profit maximisation and the MC = MR rule Normal profit, abnormal profit and economic profit Internal and external growth and types of integration Productive, allocative, dynamic and Pareto efficiency

Market Structures

Topic overview Market structure, contestability and barriers to entry Business objectives and satisficing Perfect competition and its assumptions Short run and long run equilibrium in perfect competition The efficiency of perfect competition Monopolistic competition and its assumptions Short run and long run equilibrium in monopolistic competition The efficiency of monopolistic competition Monopoly and its assumptions Monopoly compared with perfect competition The costs and benefits of monopoly Oligopoly, interdependence and concentration ratios Price and non-price competition, collusion and price leadership Game theory and the Nash equilibrium

Competition Policy and Privatisation

Topic overview Why governments are concerned about monopoly power Merger control and market investigations Cartels, restrictive practices and abuse of dominance Competition authorities and how they work Regulating natural monopolies and the utilities Contestable markets and barriers to entry The limits of competition as a policy goal Privatisation and the forms it takes Evaluating privatisation and the case for renationalisation

Market Failure and Government Intervention

Topic overview Market failure and economic efficiency Externalities, welfare loss and the socially efficient output Public goods, free riding and property rights Merit goods, demerit goods and information failure Monopoly power, factor immobility and volatile prices Taxation, subsidies and tradable pollution permits Regulation, state provision and information provision Maximum and minimum prices in agriculture, housing and labour Government failure and distortions in markets Income inequality as a market failure

The Circular Flow and Aggregate Demand

Topic overview The circular flow of income Injections, withdrawals and equilibrium national income The multiplier The accelerator Aggregate demand and its components Consumption and saving Investment and its determinants Government spending and net trade The AD function: why it slopes down and what shifts it

Aggregate Supply and the Phillips Curve

Topic overview Aggregate supply and the AD/AS framework The short run aggregate supply curve Shifts in short run aggregate supply The Neo-Classical long run aggregate supply curve The Keynesian long run aggregate supply curve Shifts in long run aggregate supply Macroeconomic equilibrium and adjustment to the long run The short run Phillips curve Expectations, the long run Phillips curve and the NAIRU Shifts in the long run Phillips curve

Economic Growth

Topic overview Macroeconomic policy objectives and the conflicts between them Measuring economic growth Actual growth and potential growth Illustrating growth on the PPF and in AD/AS analysis Output gaps The business cycle and recession The causes of economic growth Policy instruments used to create growth The benefits and costs of economic growth

Unemployment

Topic overview The labour force, economic activity and inactivity Measuring unemployment Problems in measuring unemployment accurately The economic and social costs of unemployment Cyclical unemployment and demand side causes Frictional, structural and seasonal unemployment Real wage unemployment and incentives to work The natural rate of unemployment Demand side solutions to unemployment Supply side solutions to unemployment Choosing between demand side and supply side approaches

Inflation and Deflation

Topic overview Inflation, deflation and disinflation defined Price indices, the basket and weighting Calculating index numbers and the inflation rate The main measures of inflation compared Demand-pull inflation Cost-push inflation The quantity theory of money and inflation expectations The costs of inflation Policies to control inflation Deflation and the deflationary spiral

The Balance of Payments

Topic overview The balance of payments accounts The current account and its four components The capital and financial accounts Why the balance of payments sums to zero Causes of current account imbalances The terms of trade and the current account The consequences of a deficit or a surplus Policies to correct a current account deficit

Control of the National Debt

Topic overview Deficits, surpluses and the national debt Measurement of the deficit and the debt Structural and cyclical deficits Discretionary policy and automatic stabilisers The cost of servicing debt and credit ratings Refinancing, confidence and market discipline Crowding out and the effect of debt on growth Austerity in a downturn and whether debt is always bad

Fiscal Policy

Topic overview The budget and the fiscal stance Government spending and where it goes Taxation and the sources of government revenue Direct and indirect taxes Fiscal policy, aggregate demand and AD/AS analysis The Keynesian case for demand side fiscal policy Criticisms of demand side fiscal policy The Laffer curve and tax rates Supply side fiscal policy

Monetary Policy and Financial Stability

Topic overview The Bank of England and monetary stability The inflation target and the Bank of England remit The Monetary Policy Committee and how Bank Rate is set The transmission mechanism of monetary policy Interest rates, aggregate demand and inflation Interest rates and the exchange rate Evaluating interest rates as a policy tool Quantitative easing and how it works The risks of quantitative easing and its unwinding Direct intervention in bank lending The financial sector and the real economy Asset bubbles and the financial crisis of 2007-08 Systemic risk, moral hazard and the lender of last resort Regulating the financial system UK economic turning points since 1990

Exchange Rates and Supply Side Policies

Topic overview Exchange rate determination in a free market Factors that cause a currency to appreciate or depreciate The exchange rate index and effects on households and firms Exchange rates, aggregate demand and the macroeconomic objectives Managed floats, fixed rates and central bank intervention The terms of trade and the Marshall-Lerner condition Supply side policies and long-run aggregate supply Market-based and interventionist supply side policies Evaluating supply side policies

International Trade and Protectionism

Topic overview Why countries trade Absolute and comparative advantage Calculating comparative advantage The gains from trade and the terms of trade Limits and criticisms of comparative advantage The case for free trade The case against free trade Tariffs and their effects Quotas, subsidies and other methods of protection The arguments for and against protectionism

Globalisation and the UK in the World Economy

Topic overview What globalisation is and what drives it The benefits of globalisation The costs of globalisation The United Kingdom in the world economy The World Trade Organisation Economic problems of developed, developing and emerging economies The European Union and the single market The advantages and disadvantages of membership Enlargement of the European Union Economic and monetary union and the euro Optimal currency areas and the European Central Bank

Economic Development

Topic overview What economic development means National income as a measure of development Purchasing power parity and comparing countries The Human Development Index Other indicators of development Economic structure and development Obstacles: health, education and population Obstacles: capital, infrastructure and institutions Obstacles: trade, resources and external conditions Solutions: liberalisation and foreign investment Solutions: aid and debt relief Solutions: industrialisation strategies

Economic Development

Purchasing power parity and comparing countries

3 things to know
All three components

Overview

Purchasing power parity, big Mac index and international poverty line.

What you need to know

Answer each one before you reveal it.

Your recallNot started

Evaluation

What are the limitations of purchasing power parity estimates?

Key term

What is the international poverty line?

Evaluation

Why is a single international poverty line criticised?

Questions from this subtopic

Each one with the model answer underneath.

1
Why can market exchange rates mislead when comparing incomes?
Model answer
An exchange rate reflects the currencies actually traded internationally. Prices of goods that are not traded, such as housing and local services, are far lower in poorer countries. Converting at the market rate therefore understates what an income actually buys.
2
What is purchasing power parity?
Model answer
Purchasing power parity is an exchange rate at which a given basket of goods costs the same in two countries. Incomes converted at that rate are comparable in terms of what they buy.
3
How does a purchasing power parity adjustment change the picture?
Model answer
Incomes in poorer countries rise substantially relative to richer ones once the adjustment is made. The measured gap between rich and poor economies narrows, though it remains large.
4
What is the Big Mac index?
Model answer
The Big Mac index compares the price of a single standardised product across countries. The comparison gives an accessible illustration of purchasing power parity, though one product is far too narrow a basket for serious use.
5
What are the limitations of purchasing power parity estimates?
Model answer
Constructing a comparable basket is difficult when consumption patterns differ between countries. Quality differences are hard to price. Estimates are revised substantially when the underlying price surveys are repeated.
6
What is the international poverty line?
Model answer
The international poverty line is an income threshold set in purchasing power parity terms. The World Bank uses it to count people in extreme poverty. The line has been raised several times as prices and survey data changed.

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Scarcity, Choice and the Economic Problem

Demand, Supply and Market Equilibrium

Elasticities of Demand and Supply

The Labour Market

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