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Purchasing Power Parity (PPP) is an economic measure used to compare the price of specific goods in different countries to assess currency purchasing power.
Answer: True
Explanation: Purchasing Power Parity (PPP) is indeed an economic measure employed to compare the prices of specific goods across different countries, thereby evaluating the comparative purchasing power of their respective currencies.
Purchasing Power Parity is based on the 'law of diminishing returns,' which suggests prices should equalize across locations.
Answer: False
Explanation: Purchasing Power Parity is fundamentally based on the 'law of one price,' not the 'law of diminishing returns.' The law of one price posits that identical goods should have the same price globally when trade barriers are absent.
The core idea of PPP is that consumers in every location should have the same purchasing power when the correct exchange rate is applied.
Answer: True
Explanation: The fundamental concept of Purchasing Power Parity (PPP) is that, theoretically, with the appropriate exchange rate, consumers in different locations should possess equivalent purchasing power, enabling them to acquire the same quantity of goods and services.
Relative PPP focuses on the absolute price levels of goods between countries at a single point in time.
Answer: False
Explanation: Relative PPP focuses on the *changes* in exchange rates and inflation differentials over time, whereas Absolute PPP posits that exchange rates should equalize the price ratios of goods between countries at a specific point in time.
The law of one price is the theoretical foundation for PPP, stating identical goods should have the same price globally without barriers.
Answer: True
Explanation: The law of one price serves as the foundational principle for PPP, asserting that identical goods should command the same price across different locations when free from trade barriers and transaction costs.
What is the fundamental principle underpinning the concept of Purchasing Power Parity (PPP)?
Answer: The law of one price.
Explanation: The fundamental principle underpinning Purchasing Power Parity is the 'law of one price,' which posits that identical goods should have the same price in different locations when trade barriers are absent.
What does the term 'purchasing power parity' imply about consumers?
Answer: Consumers in every location should possess the same purchasing power with the correct exchange rate.
Explanation: The term 'purchasing power parity' implies that, when using the correct exchange rate, consumers in all locations should have equivalent purchasing power, enabling them to buy the same basket of goods and services.
What is the primary difference between Relative PPP and Absolute PPP?
Answer: Absolute PPP posits exchange rates equal price ratios, while Relative PPP focuses on changes in exchange rates matching inflation differentials.
Explanation: Absolute PPP suggests that exchange rates should equal the ratio of price levels between countries for a basket of goods, while Relative PPP focuses on the relationship between changes in exchange rates and inflation differentials over time.
The PPP exchange rate is calculated by dividing the price of a market basket in one location by the price of a different basket in another location.
Answer: False
Explanation: The PPP exchange rate is calculated by dividing the price of a specific market basket of goods in one country by the price of the identical market basket in another country, not a different basket.
The OECD calculates PPP using a basket of goods that includes approximately 3,000 consumer goods and services, along with equipment goods and construction projects.
Answer: True
Explanation: The Organisation for Economic Co-operation and Development (OECD) utilizes a comprehensive basket for PPP calculations, encompassing approximately 3,000 consumer goods and services, alongside equipment goods and construction projects, to ensure robust comparisons.
Using a single good to measure PPP is considered reliable because it simplifies the comparison process.
Answer: False
Explanation: Measuring PPP with a single good is generally considered unreliable due to factors like tariffs, transportation costs, and differing consumption patterns, which prevent accurate price reflection. A basket of goods is preferred for greater accuracy.
When economic data is 'PPP-adjusted,' it means the figures have been modified to account for differences in the cost of living between countries.
Answer: True
Explanation: Economic data that is 'PPP-adjusted' has been modified to reflect variations in price levels and the cost of living across different countries, facilitating more accurate cross-national comparisons of economic performance and living standards.
The primary controversy in PPP calculation is the ease of finding comparable goods across countries.
Answer: False
Explanation: The primary controversy in PPP calculation lies in the difficulty of finding truly comparable baskets of goods and services across diverse countries due to variations in consumption patterns, quality, and availability, not the ease of finding them.
Differences in consumption patterns and quality do not significantly affect PPP calculations.
Answer: False
Explanation: Differences in consumption patterns and the quality of goods and services significantly affect PPP calculations, as they influence the composition and representativeness of the market basket used for comparison.
A theoretical challenge in PPP arises when comparing individuals with vastly different consumption baskets, like those consuming teff versus rice.
Answer: True
Explanation: A significant theoretical challenge in PPP arises when comparing individuals with disparate consumption baskets, particularly if staple foods are not commercially available in the comparator country, rendering direct price comparisons impossible for those items.
CPI measures price changes across different countries at a specific point in time, while PPP measures price changes over time within a country.
Answer: False
Explanation: The Consumer Price Index (CPI) measures price changes over time within a single country (inflation), whereas Purchasing Power Parity (PPP) measures price level differences across countries at a specific point in time.
The Geary-Khamis dollar is used as a common unit of account in PPP calculations to compare economic data across countries.
Answer: True
Explanation: The Geary-Khamis dollar, often referred to as the 'international dollar,' functions as a standardized unit of account within PPP calculations, facilitating the comparison of economic data, such as GDP per capita, across different nations.
The OECD measures differences in price levels monthly by calculating PPP ratios against market exchange rates for private consumption expenditure.
Answer: True
Explanation: The OECD does measure monthly differences in price levels by calculating PPP ratios for private consumption expenditure against market exchange rates, providing a comparative view of living costs.
Relative PPP can fail tests based on official price indexes due to consistent price levels across components.
Answer: False
Explanation: Relative PPP can fail tests based on official price indexes due to *inconsistent* changes in the relative prices of components within a basket, not consistent price levels. These shifts can cause deviations from predicted exchange rate movements.
How is the PPP exchange rate calculated according to the provided text?
Answer: By dividing the price of a market basket in one country by the price of the same basket in another country.
Explanation: The PPP exchange rate is calculated by dividing the price of a specific market basket of goods in one country by the price of the identical market basket in another country.
According to the OECD, what is a key component included in their PPP calculation basket?
Answer: Approximately 3,000 consumer goods and services, plus equipment and construction.
Explanation: The OECD's PPP calculation basket includes approximately 3,000 consumer goods and services, along with equipment goods and construction projects, to provide a comprehensive measure.
Why is using a single good to measure PPP potentially misleading?
Answer: Factors like poverty, tariffs, and transportation costs prevent accurate price reflection.
Explanation: Using a single good for PPP measurement is misleading because factors such as poverty, tariffs, and transportation costs impede accurate price reflection and comparison across countries.
When economic data is 'PPP-adjusted,' what does this signify?
Answer: The figures have been modified to account for differences in price levels and cost of living.
Explanation: When economic data is 'PPP-adjusted,' it signifies that the figures have been modified to account for variations in price levels and the cost of living between countries, enabling more accurate comparisons.
What is the primary difference in measurement focus between CPI and PPP?
Answer: CPI measures price changes over time within a country, while PPP measures price level changes across countries.
Explanation: The primary difference is that CPI measures price changes over time within a country (inflation), whereas PPP measures price level changes across different countries at a specific point in time.
What does the OECD table comparing price levels indicate about the cost of goods relative to the United States?
Answer: It shows the number of US dollars needed in various countries to buy what $100 buys in the US.
Explanation: The OECD table comparing price levels indicates the amount of US dollars required in various countries to purchase the same basket of goods and services that $100 would buy in the United States, illustrating relative cost differences.
What is the significance of the Geary-Khamis dollar?
Answer: It is a unit of account used to compare economic data across countries in PPP calculations.
Explanation: The Geary-Khamis dollar is significant as it serves as a common unit of account in PPP calculations, enabling the comparison of economic data, such as GDP, across different countries.
What theoretical challenge arises when comparing the purchasing power of individuals with vastly different consumption baskets?
Answer: If staple foods are not commercially available in the other country, direct price comparison is impossible.
Explanation: A theoretical challenge in PPP arises when comparing individuals with vastly different consumption baskets, particularly if staple foods are not commercially available in the comparator country, making direct price comparison impossible for those specific items.
What is the role of the International Comparison Program (ICP) in PPP estimation?
Answer: It provides PPP estimates for many countries, relying on their statistical capacity.
Explanation: The International Comparison Program (ICP) plays a crucial role by providing PPP estimates for numerous countries, contingent upon the statistical capacity of participating nations to disaggregate their national accounts data.
Tariffs and transaction costs are factors that can cause PPP exchange rates to align perfectly with market exchange rates.
Answer: False
Explanation: Tariffs and transaction costs are impediments that prevent PPP exchange rates from aligning perfectly with market exchange rates; instead, they contribute to deviations between the two.
Market exchange rates are generally more stable over time compared to PPP exchange rates.
Answer: False
Explanation: Market exchange rates are typically more volatile due to fluctuations in currency markets, whereas PPP exchange rates tend to be more stable over longer periods, reflecting underlying price levels.
Longer-term differences between market and PPP exchange rates can be explained by factors like tariffs and differences in the price of labor.
Answer: True
Explanation: Factors such as tariffs, transaction costs, and variations in the price of labor, as articulated by the Balassa-Samuelson theorem, contribute to persistent differences between market and PPP exchange rates over extended periods.
Non-tradable goods, like electricity, tend to align their prices more closely with the market exchange rate than with the PPP exchange rate.
Answer: False
Explanation: Non-tradable goods and services, such as electricity, tend to align their prices more closely with the PPP exchange rate because their prices are determined by domestic factors and are less influenced by international trade and market exchange rates.
The Balassa-Samuelson effect suggests that lower-income countries have a cost advantage in producing tradable goods due to cheaper labor and non-tradables.
Answer: True
Explanation: The Balassa-Samuelson effect posits that lower-income countries possess a cost advantage in tradable goods production because their labor and non-tradable goods are generally cheaper, leading to lower overall production costs.
Transport costs and trade restrictions strengthen the law of one price and PPP by making goods cheaper to move between markets.
Answer: False
Explanation: Transport costs and trade restrictions weaken the law of one price and PPP by increasing the cost of moving goods between markets, thereby allowing for greater price divergence and hindering the equalization of prices.
Pricing to market, where firms set different prices in different markets, supports the law of one price.
Answer: False
Explanation: Pricing to market, characterized by firms setting varied prices across different markets, directly contradicts and violates the law of one price by creating price discrepancies for identical goods.
Which of the following is identified as a factor that causes PPP exchange rates to differ from market exchange rates?
Answer: Trade impediments and tariffs.
Explanation: Trade impediments, such as tariffs and transaction costs, are identified as key factors that cause PPP exchange rates to diverge from market exchange rates.
How do market exchange rates generally compare to PPP exchange rates in terms of stability?
Answer: PPP rates are more stable; market rates are volatile.
Explanation: Market exchange rates are generally more volatile due to market forces, while PPP exchange rates tend to be more stable over time, reflecting underlying price level adjustments.
Which theorem is mentioned as explaining longer-term differences between market and PPP exchange rates due to factors like labor prices?
Answer: The Balassa-Samuelson theorem.
Explanation: The Balassa-Samuelson theorem is cited as explaining longer-term divergences between market and PPP exchange rates, attributing these differences to factors such as variations in the price of labor and non-tradable goods.
Which category of goods tends to move closer to the PPP exchange rate?
Answer: Non-tradable goods and services.
Explanation: Non-tradable goods and services, such as local services and construction, tend to align their prices more closely with the PPP exchange rate because they are less affected by international trade and market exchange rate fluctuations.
The Balassa-Samuelson effect explains cost advantages in lower-income countries primarily due to:
Answer: Lower prices for non-tradable goods and cheaper labor.
Explanation: The Balassa-Samuelson effect explains cost advantages in lower-income countries by noting that they typically have lower prices for non-tradable goods and cheaper labor, which reduces overall production costs.
How does 'pricing to market' affect the law of one price?
Answer: It leads to violations of the law of one price by creating price discrepancies.
Explanation: 'Pricing to market,' where firms set different prices in different markets, leads to violations of the law of one price by creating price discrepancies for identical goods across locations.
PPP is utilized to compare economies based on indicators like Gross Domestic Product (GDP) and labor productivity.
Answer: True
Explanation: Purchasing Power Parity (PPP) is indeed employed for comparing national economies, particularly in relation to indicators such as Gross Domestic Product (GDP) and labor productivity, offering a more accurate measure of economic output and living standards.
PPP exchange rates are primarily used for short-term currency trading strategies.
Answer: False
Explanation: PPP exchange rates are primarily utilized for long-term economic comparisons and analyses, such as assessing national production and consumption levels, rather than for short-term currency trading.
PPP adjustments can significantly alter the perception of a country's economic standing, as seen in India's GDP per capita comparison.
Answer: True
Explanation: PPP adjustments can indeed substantially change the perception of a country's economic position. For example, India's GDP per capita, when adjusted for PPP, indicates a significantly higher standard of living than when measured using nominal exchange rates.
PPP exchange rates are useful when official exchange rates are artificially manipulated by governments.
Answer: True
Explanation: PPP exchange rates are particularly valuable for economic analysis when official exchange rates are subject to artificial manipulation or significant deviation from market fundamentals, providing a more stable basis for comparison.
The Penn effect describes the tendency for market exchange rates to perfectly reflect PPP.
Answer: False
Explanation: The Penn effect, derived from the Penn World Table, highlights a systematic bias that occurs when using market exchange rates for international comparisons, indicating that market rates do not perfectly reflect PPP due to price level differences.
The image caption describes a visualization of GDP (PPP) by country for the year 2022, as reported by the IMF.
Answer: True
Explanation: The provided image caption accurately describes a visualization of GDP adjusted for Purchasing Power Parity (PPP) for the year 2022, as reported by the International Monetary Fund (IMF).
Using market exchange rates for international comparisons avoids false inferences about a country's production levels compared to PPP.
Answer: False
Explanation: Using market exchange rates for international comparisons can lead to false inferences about production levels because they do not account for differences in the cost of living. PPP-adjusted rates provide a more accurate measure of a country's actual production capacity.
An IMF spokesperson stated in 2011 that PPP is always the most appropriate measure for comparing country sizes globally.
Answer: False
Explanation: In 2011, an IMF spokesperson indicated that GDP measured at market exchange rates is often considered more relevant than PPP for comparing the relative size of countries in the global economy, as PPP is influenced by non-traded services.
The IMF considers GDP measured at market exchange rates more relevant for comparing the relative size of countries within the global economy.
Answer: True
Explanation: The IMF generally regards GDP measured at market exchange rates as more pertinent for comparing the relative size of countries within the global economic landscape, as it reflects international trade and financial valuations more directly.
The Big Mac Index uses a Big Mac burger as its single basket of goods to informally assess currency valuation.
Answer: True
Explanation: The Big Mac Index, developed by *The Economist*, employs a Big Mac burger as its singular basket of goods to provide an informal assessment of currency valuation and purchasing power parity.
Limitations of the Big Mac Index include the perishability of Big Macs and their absence in all countries.
Answer: True
Explanation: Significant limitations of the Big Mac Index include the perishability of the product and its unavailability in certain countries, which contravenes the assumptions required for a precise PPP calculation.
Angus Deaton suggests that PPP indices for poverty measurement should give more weight to luxury items.
Answer: False
Explanation: Angus Deaton argues that PPP indices used for poverty measurement should be reweighted to emphasize essential local food items and reflect local poverty measures more accurately, rather than giving more weight to luxury items.
The Big Mac Index is considered a perfect measure of PPP due to the Big Mac's global standardization.
Answer: False
Explanation: While the Big Mac is relatively standardized, the Big Mac Index is considered an informal and imperfect measure of PPP due to various factors, including local taxes, transportation costs, and differing input prices, which cause deviations from true parity.
The KFC Index was developed to measure PPP in African countries where McDonald's is not widely available.
Answer: True
Explanation: The KFC Index was indeed created to facilitate PPP measurements in African nations where McDonald's restaurants are less prevalent, utilizing a KFC bucket as the comparable item.
The iPad Index is considered more standardized than the Big Mac Index because iPads are typically produced in a single location.
Answer: True
Explanation: The iPad Index is often considered more standardized for PPP comparisons than the Big Mac Index, as iPads are generally manufactured in a singular location, leading to fewer variations in production inputs.
The global poverty line is determined by counting people below an international poverty line, often calculated using PPP exchange rates.
Answer: True
Explanation: The global poverty line is indeed determined by assessing the number of individuals living below a specified international poverty threshold, which is frequently calculated using PPP exchange rates to ensure cross-country comparability.
The IMF believes PPP is more relevant for comparing country sizes globally because it includes non-traded services.
Answer: False
Explanation: The IMF generally considers market exchange rates more relevant for comparing country sizes globally, as PPP levels are influenced by non-traded services which are more domestically oriented, whereas market rates better reflect international trade and financial valuations.
What economic indicators are mentioned as being compared using PPP?
Answer: GDP, labor productivity, and actual individual consumption.
Explanation: Economic indicators such as Gross Domestic Product (GDP), labor productivity, and actual individual consumption are mentioned as being compared using PPP.
What example illustrates how PPP adjustments can significantly alter the perception of a country's economic standing?
Answer: India's GDP per capita increasing substantially when adjusted for PPP.
Explanation: India's GDP per capita, which increases substantially when adjusted for PPP, serves as an example of how PPP adjustments can significantly alter the perception of a country's economic standing and standard of living.
According to the source, when are PPP exchange rates most useful for economic analysis?
Answer: When official exchange rates are artificially manipulated or market rates deviate significantly.
Explanation: PPP exchange rates are particularly useful for economic analysis when official exchange rates are artificially manipulated or when market rates deviate substantially from their long-term equilibrium, providing a more stable basis for comparison.
What does the 'Penn effect' highlight in the context of PPP?
Answer: A systematic bias when using market exchange rates for international comparisons due to price level differences.
Explanation: The 'Penn effect' highlights a systematic bias that arises when market exchange rates are used for international comparisons, indicating that price level differences can distort these assessments, meaning market rates do not perfectly reflect PPP.
How does the IMF view the relevance of PPP versus market exchange rates for comparing the relative size of countries in the global economy?
Answer: Market exchange rates are more relevant as they reflect international trade and financial valuations.
Explanation: The IMF generally considers market exchange rates more relevant for comparing the relative size of countries in the global economy because they better reflect international trade and financial market valuations, whereas PPP is influenced by domestically-oriented non-traded services.
What is a significant limitation of the Big Mac Index mentioned in the text?
Answer: Big Macs are perishable and not easily transported, violating the law of one price.
Explanation: A significant limitation of the Big Mac Index is that Big Macs are perishable and not easily transported across borders, which violates the 'law of one price' assumption crucial for PPP calculations.
How does the KFC Index differ from the Big Mac Index?
Answer: It uses a different fast-food item (KFC bucket) for regions lacking McDonald's.
Explanation: The KFC Index differs from the Big Mac Index by employing a KFC bucket as its comparable item, specifically designed for use in African countries where McDonald's restaurants are not widely available.
What issue does Angus Deaton raise regarding PPP indices for poverty measurement?
Answer: PPP indices should be reweighted to better reflect local poverty measures, emphasizing essential local food items.
Explanation: Angus Deaton raises the issue that PPP indices for poverty measurement should be reweighted to better reflect local poverty measures, giving greater emphasis to essential local food items rather than potentially skewing the results with luxury goods.
Why is the Big Mac considered a useful, though imperfect, item for the Big Mac Index?
Answer: It is a globally standardized product incorporating input costs from various sectors.
Explanation: The Big Mac is considered useful for the Big Mac Index because it is a relatively standardized product globally, incorporating input costs from diverse sectors such as agriculture, labor, and rent, making it a proxy for broader economic price structures.
Gustav Cassel proposed PPP as a descriptive model of how exchange rates are determined in free markets.
Answer: False
Explanation: Gustav Cassel proposed the PPP doctrine primarily as a normative policy recommendation for stabilizing exchange rates post-WWI, rather than solely as a descriptive model of existing market determination.
The concept of Purchasing Power Parity can be traced back to the 16th-century School of Salamanca.
Answer: True
Explanation: The intellectual origins of Purchasing Power Parity can indeed be traced back to the 16th-century School of Salamanca, indicating a long history of thought on comparing currency values based on purchasing power.
Henry Thornton was the first to clearly explain the self-adjusting mechanism that keeps exchange rates close to PPP.
Answer: True
Explanation: Henry Thornton is credited as the first economist to articulate clearly the self-adjusting mechanism that maintains exchange rates in proximity to their purchasing power parity levels.
Gustav Cassel's PPP doctrine was a policy recommendation to fix exchange rates at their PPP level to stabilize trade.
Answer: True
Explanation: Gustav Cassel's formulation of the PPP doctrine served as a policy recommendation aimed at stabilizing international exchange rates by fixing them at their purchasing power parity levels, thereby fostering trade stability.
What was Gustav Cassel's primary goal in proposing the PPP doctrine post-WWI?
Answer: To provide a normative policy recommendation for stabilizing exchange rates and restoring the gold standard.
Explanation: Gustav Cassel's primary goal in proposing the PPP doctrine post-WWI was to offer a policy recommendation for stabilizing exchange rates and facilitating the restoration of the gold standard, rather than merely describing market mechanisms.