Lecture 04 (Oct 8) PDF

GDP Wrap-Up 1 October 8, 2024 ARE/ECN 115A 1 2 Business 2  Readings 3  Today GDP; PPP; CPI; HDI  T&L, Ch 3 “Income” & Ch 6: “Human Development”,  Thursday: Introduction to Poverty Measureme...

GDP Wrap-Up 1 October 8, 2024 ARE/ECN 115A 1 2 Business 2  Readings 3  Today GDP; PPP; CPI; HDI  T&L, Ch 3 “Income” & Ch 6: “Human Development”,  Thursday: Introduction to Poverty Measurement  T&L, Ch 4: “Poverty”, pp 76 – 83 3  Sections This Week 4  In-Depth look at Human Development Index  Take laptops!  NEW ROOM LOCATIONS!! 4  Clickers 5  Points start today  Let’s try it out Clicker Question I know that Problem Set 1 is long and it is very important that I get a good start. As a result: A. I have already completed it and triple checked my work. B. I have made a good start and am confident that I will have time to complete a high-quality Problem Set before Sunday. C. Give me a break…it’s only Tuesday! 5  Problem Set 1 6  Due Sunday  See announcements for clarifications on:  Dealing with missing values;  Expenditure shares (Use Shares from Table 3.1…do NOT assume they are the same in all countries) 6  Office Hours Before PS1 Due Date  Professor Boucher (2102 SSH)  Wednesday, Noon – 1:30 pm  TA’s (in 2136 or 2143 SSH)  Adelaida: Wednesday, 10 am – Noon  Warda: Thursday, 2 – 4 pm  Aisha: Thursday, 4:30 – 6:30 pm  Takashi: Friday, 12:30 – 2:30 pm 7 8 Announcements 8 9 9 10 10 Reflections 11  Reflection: PPP  “I found the example of Big Mac and beer is a bit challenging since it includes a lot of calculation and comparison. It was discussed in the last part of the lecture, further detailed explanation or similar example would be great.”  Don’t worry…we’ll summarize and do examples today! 12  Reflection: Amartya Sen  “I liked Amartya Sen’s notion of development where he says development exists when individuals have the capacity to achieve the kind and quality of lives they value. He argues that income is an important indicator to measure development, but there are other things that matter too. Indeed, development can’t always be framed with statistical measures; development can be intangible that numbers or data might not be able to explain. I am very excited to learn more about him and his work and on how economic theories address such nuances of development.”  Won’t have time to go more in-depth about Sen, but see “Interview with Amartya Sen: On Freedom and Opportunity” on Canvas/Module 1 13  Reflection: Intermediate vs Final Services  “Something that I need more practice on is learning the difference between intermediate and final services. When it comes to goods I find it pretty straightforward, however, I find services to be more challenging. For example, I'm not sure what the final service is considered to be if you hire one firm to complete a service for you, and then they hire others to help carry out that service.” 14  Alex owns Laughing Dogs, a company that provides training and walking services.  My wife and I pay Alex $50 per week to walk and train Oso for one hour on Tuesday and Thursday mornings. CLICKER QUESTION The money we pay Alex is included in California’s GDP in the Expenditure Method.  TRUE  FALSE  Alex owns Laughing Dogs, a company that provides training and walking services.  Acme Security company in Sacramento pays Alex $20,000 per year to train guard dogs and security agents.  Factories in Sacramento pay Acme Security to provide security in the form of security agents and guard dogs. CLICKER QUESTION The $20,000 Acme Security pays Alex is included in California’s GDP in the Expenditure Method.  TRUE  FALSE  What About Advertising?  Last night I ordered new chopsticks.  There are many forms of digital advertising. Pay-Per Click advertising is one of the most common.  Google provides the service of directing clients to Williams-Sonoma website.  Williams-Sonoma pays Google money each time somebody clicks on the ad. QUESTION Is the money paid by Williams-Sonoma to Google counted in GDP in the Expenditure Method? A. YES B. NO 17 Comparing GDP per Capita Across Countries Purchasing Power Parity (PPP) 18  Reflection: PPP  “I really liked learning about purchasing power parity. I’m a first generation immigrant and I remember when I first got a job my dad would lecture me about buying coffee he would always say "that 100 dollars that you spent on coffee this month is the amount your grandpa gets paid" and id always try to explain that his salary is adjusted to where he lives. I never knew the name for it and now I do so I really liked it because I was instantly able to connect it to my life.”  When thinking about how well off people are in different locations, we need to take into account price differences. i.e., how far does a given amount of USD go? 19  Comparing GDP per Capita  GDP per Capita is commonly used to compare well-being across countries.  Imagine an “Average Joe” in every country  Average Joe earns an income exactly equal to the level of GDP per Capita in his country;  Our Goal: Make sure that the GDP per Capita numbers reflect how much stuff our Average Joes can purchase in their countries (i.e., that it reflects their “purchasing power”)  Making meaningful comparisons based on GDP per Capita requires:  Convert local currencies to a common currency (USD)  Use an exchange rate that reflects prices levels 20  A B C D = B/C Country GDP per Capita OXR GDP per Capita (LCU) (LCU per 1 USD) (USD OXR) Japan 4,473,000 JPY 131 JPY/USD 34,145 USD Colombia 28,219,770 COP 4,380 COP/USD 6,443 USD Pakistan 282,581 PKR 190 PKR/USD 1,487 USD US 77,246 USD 1 USD/USD 77,246 USD  We started by converting GDP per Capita to USD using OXR  We found that, if they went to a bank and converted their local currency income to USD using the OXR, then the “Average Joe”…  …in Japan would have about 44% (= 34,145/77,246) of the USD earned by the Average Joe in the US.  …in Colombia would have about 8% (= 6,443/77,246) of the USD earned by the Average Joe in the US.  …in Pakistan would have about 2% (= 1,497/77,246) of the USD earned by the Average Joe in the US.  But does this mean that:  The Average Joe in Japan consumes only 44% as much the Average Joe in US?  The Average Joe in Colombia consumes only 8% as much as the Average Joe in US?  The Average Joe in Pakistan consumes only 2% as much as the Average Joe in US? 21  A B C D = B/C Country GDP per Capita OXR GDP per Capita (LCU) (LCU per 1 USD) (USD OXR) Japan 4,473,000 JPY 131 JPY/USD 34,145 USD Colombia 28,219,770 COP 4,380 COP/USD 6,443 USD Pakistan 282,581 PKR 190 PKR/USD 1,487 USD US 77,246 USD 1 USD/USD 77,246 USD  No!! Not if Prices are different across these countries!!  Let’s assume that many things are more expensive in the US than Japan, Colombia and Pakistan.  Then the following still holds…  We found that, if they went to a bank and converted their local currency income to USD using the OXR, then the “Average Joe”…  …in Japan would have about 44% (= 34,145/77,246) of the USD earned by the Avg Joe in the US.  …in Colombia would have about 8% (= 6,443/77,246) of the USD earned by the Avg Joe in the US.  …in Pakistan would have about 2% (= 1,497/77,246) of the USD earned by the Avg Joe in the US.  But because things are more expensive in the US:  The Average Joe in Japan consumes MORE THAN 44% as much the Average Joe in US.  The Average Joe in Colombia consumes MORE THAN 8% as much as the Average Joe in US.  The Average Joe in Pakistan consumes only MORE THAN 2% as much as the Average Joe in US. 22  Prices and Purchasing Power  Let’s make two additional assumptions.  Prices: People only consume two things: 1) Big Macs and 2) Tsingtao Beer  Budget Shares: People spend 50% of their income on Big Macs and 50% of their income on Beer. Big Mac Tsingtao Beer A B C D E=(BxD)/C F G H=(GxB)/F Country GDP per Capita Local Budget Quantity Local Budget Quantity (LCU) Price Share Consumed Price Share Consumed Japan 4,473,000 480 0.5 4,659 262 0.5 8,536 JPY JPY JPY Colombia 28,219,770 15,330 0.5 920 8,760 0.5 1,611 COP COP COP Pakistan 282,581 600 0.5 235 380 0.5 372 PKR PKR PKR US 77,246 5.7 0.5 6,776 2 0.5 19,311 USD USD USD In today’s lecture, Michael showed lots of graphs that compared income per capita across different countries; It may sound straightforward, but making a meaningful comparison – that reflects the real purchasing power of incomes –is not so simple. Consider Michael’s example from lecture which compared “Two Average Joes” Joe in Davis earns $110 per month Zhou in Beijing earns 660 Yuan per month Who’s actually better off in terms of being able to buy more stuff? Without a lot more information, we really can’t compare their incomes. In order to make these comparisons meaningful, we have to deal with two challenges. First: Joe and Zhou earn their salaries in different currencies. So we’ll need to convert to the same currency in order to compare. Typically we’ll convert to dollars. Second, prices may be quite different in the two countries  This means that a given amount of money, let’s say110 USD, will buy more stuff in one country than the other. Purchasing Power Parity is a way to deal with this second problem. It will allow us to take into account differences in prices across countries when making income comparisons. 23  Big Mac Tsingtao Beer A B C D E=(BxD)/C F G H=(GxB)/F Country GDP per Capita Local Budget Quantity Local Budget Quantity (LCU) Price Share Consumed Price Share Consumed Japan 4,473,000 480 0.5 4,659 262 JPY 0.5 8,536 JPY JPY Colombia 28,219,770 15,330 0.5 920 8,760 0.5 1,611 COP COP COP Pakistan 282,581 600 0.5 235 380 0.5 372 PKR PKR PKR US 77,246 5.7 0.5 6,776 2 0.5 19,311 USD USD USD  Now compare amount consumed by Average Joes across countries:  Avg Joe in Japan consumes 69% as much BM and 44% as much Beer compared to Avg Joe in US. (GDP per capita was 44% of US’s using OXR)  Avg Joe in Colombia consumes 14% as much BM ad 8% as much Beer compared to Avg Joe in US. (GDP per capita was 8% of US’s using OXR)  Avg Joe in Pakistan consumes 4% as much BM and 2% as much Beer compared to Avg Joe in US (GDP per capita was 2% of US’s using OXR)  What’s going on?? In today’s lecture, Michael showed lots of graphs that compared income per capita across different countries; It may sound straightforward, but making a meaningful comparison – that reflects the real purchasing power of incomes –is not so simple. Consider Michael’s example from lecture which compared “Two Average Joes” Joe in Davis earns $110 per month Zhou in Beijing earns 660 Yuan per month Who’s actually better off in terms of being able to buy more stuff? Without a lot more information, we really can’t compare their incomes. In order to make these comparisons meaningful, we have to deal with two challenges. First: Joe and Zhou earn their salaries in different currencies. So we’ll need to convert to the same currency in order to compare. Typically we’ll convert to dollars. Second, prices may be quite different in the two countries  This means that a given amount of money, let’s say110 USD, will buy more stuff in one country than the other. Purchasing Power Parity is a way to deal with this second problem. It will allow us to take into account differences in prices across countries when making income comparisons. 24  Big Mac Beer A B C D=C/B E F=E/B Country OXR Local Price USD Price Local Price USD Price Japan 131 JPY/USD 480 JPY 3.7 USD 262 JPY 2 USD Colombia 4,380 COP/USD 15,330 COP 3.5 USD 8,760 COP 2 USD Pakistan 190 PKR/USD 600 PKR 3.2 USD 380 PKR 2 USD US 1 USD/USD 5.7 USD 5.7 USD 2 USD 2 USD  There are important price differences in Big Mac across countries!  When we compare GDP per Capita across countries, we want it to reflect the purchasing power of individuals. So we must take into account price differences.  If we convert GDP per Capita to USD using OXR, we are NOT taking into account price differences.  This is why we need the Purchasing Power Parity exchange rate.  NOTE!! You cannot go to a bank and ask to convert currencies using the PPP exchange rate!!  The PPP exchange rate is a theoretical concept that we (economists) use to make meaningful comparisons across countries 25  Big Mac Beer A B C D=C/B E F=E/B Country OXR Local Price USD Price Local Price USD Price Japan 131 JPY/USD 480 JPY 3.7 USD 262 JPY 2 USD Colombia 4,380 COP/USD 15,330 COP 3.5 USD 8,760 COP 2 USD Pakistan 190 PKR/USD 600 PKR 3.2 USD 380 PKR 2 USD US 1 USD/USD 5.7 USD 5.7 USD 2 USD 2 USD  But first…  Why are Big Macs so much more expensive in the US??  Why is a Tsingtao beer the same price across all countries? In today’s lecture, Michael showed lots of graphs that compared income per capita across different countries; It may sound straightforward, but making a meaningful comparison – that reflects the real purchasing power of incomes –is not so simple. Consider Michael’s example from lecture which compared “Two Average Joes” Joe in Davis earns $110 per month Zhou in Beijing earns 660 Yuan per month Who’s actually better off in terms of being able to buy more stuff? Without a lot more information, we really can’t compare their incomes. In order to make these comparisons meaningful, we have to deal with two challenges. First: Joe and Zhou earn their salaries in different currencies. So we’ll need to convert to the same currency in order to compare. Typically we’ll convert to dollars. Second, prices may be quite different in the two countries  This means that a given amount of money, let’s say110 USD, will buy more stuff in one country than the other. Purchasing Power Parity is a way to deal with this second problem. It will allow us to take into account differences in prices across countries when making income comparisons. 26  Price Differences across Countries  Why can the same good (or service) have a different prices across countries?  Reason 1: Non-Tradable goods (as opposed to Tradable goods) often have different prices across countries.  Reason 2: Government policy can increase or decrease the price of both Non-Tradable and Tradable goods and thus create differences in price levels across countries. 27  Tradables vs Non-Tradables  A good or service is a tradable if its price is determined on the world market.  A good or service is a non-tradable if its price is determined locally.  Question: Since we live in such a globalized world, why would any good or service be non-tradable? 28  Reasons for Non-Tradables  High transportation costs (relative to value)  Cement  Services for which producer and consumer must be in same place  Restaurant meals, haircuts, etc. 29  Prices of Tradables vs Non-Tradables  The price of tradables should be pretty similar across countries.  QUESTION: If a kg of corn costs $1 in the US and $2 in Japan, what would you do?  Buy a whole bunch of corn for $1 in the US and sell it for $2 in Japan!!  This process of “arbitrage” drives the price of corn (and other tradables) to be similar across countries.  The price of non-tradables is instead determined by local supply and demand conditions, which can be very different across countries. 30  Clicker Question  Non-tradable goods tend to be more expensive in rich countries compared to poor countries. A. TRUE B. FALSE 31  Back to Big Macs  We saw that the price of a Big Mac is much higher in the US than Pakistan.  A Big Mac is not just the burger, it’s the in-restaurant dining experience…so it is a non-tradable service.  The price of a Big Mac should thus be determined by local supply and demand conditions.  Most importantly, supply curves are affected by cost of production. 32  Back to Big Macs  The costs of production are definitely higher in the US than Pakistan  The biggest cost for restaurants like McDonalds is labor  Minimum wage in the US ranges from USD 7.25 (Alabama) to USD 16 (CA) per hour  1,160 USD/Month to 2,560 USD/Month  Minimum wage in Pakistan = 195 USD/Month  This is typical…the poorer the country, the lower are key costs of production such as unskilled labor and land (rent).  This, in turn, implies that the price of non-tradables tend to be positively related to countries’ income per capita (the richer the country, the more expensive are non-tradables). 33  Government Policy  Even if a good is easily traded across borders, prices that consumers face can be quite different because of:  Taxes & Tariffs raise the price paid by consumers  Subsidies lower the price paid by consumers  Price of a Gallon of Gasoline  California: $5.93  Louisiana: $3.29  Switzerland: $7.30 34  Taking Stock  If we compare income-per capita across countries using official exchange rate, we tend to under-state purchasing power of people in lower-income countries.  Why? A given amount of USD goes farther in lower- income countries.  The Purchasing Power Parity (PPP) exchange rate converts a country’s per-capita income into USD in a way that reflects differences in prices and purchasing power. 35  Calculating the PPP Exchange Rate  In the real world, people consume many goods and services. So we define a basket of goods which contains the same items for all countries.  Once that basket is defined, follow these basic steps to computing PPP exchange rate.  Step 1: Calculate the price ratio for each good (= ,  Big Mac in Colombia: 2,689 𝐶𝑃/𝑈𝑆𝐷.  This is the price ratio for the Big Mac  Repeat this for ALL goods in the “basket”  Step 2: Compute the weighted average of all of these price ratios, where the weights are the expenditure shares on each good in the local country.  Expenditure share is just the fraction of money the “average” household spends on the good.  That’s it…the weighted average of the price ratios is the PPP exchange rate 36  Example: PPP XR in Colombia Good Price in Price in Expenditure US Colombia Share Big Mac 5.7 USD 15,330 CP 50% Beer 2 USD 8,760 CP 50%  Step 1: Calculate Price Ratio for Each Good: ,  Price ratio for Big Mac = 2,689 𝐶𝑃/USD. ,  Price ratio for Beer = 4,380 CP/USD  Step 2: Calculate the weighted average of the price ratios:  𝑋𝑅 𝐸𝑥𝑝 𝑆ℎ𝑎𝑟𝑒 𝐵𝑀 𝑥 𝑃𝑟𝑖𝑐𝑒 𝑅𝑎𝑡𝑖𝑜 𝐵𝑀 𝐸𝑥𝑝 𝑆ℎ𝑎𝑟𝑒 𝐵𝑒𝑒𝑟 𝑥 𝑃𝑟𝑖𝑐𝑒 𝑅𝑎𝑡𝑖𝑜 𝐵𝑒𝑒𝑟  𝑋𝑅 0.5 ∗ 2,689 0.5 ∗ 4,380 3,534.5 𝐶𝑃/USD  Recall: OXR in Colombia was 4,380 CP = 1 USD 28,219,770 Pesos  GDP per capita with OXR was 6,443 USD (= 4,380 Pesos/USD ) 28,219,770 Pesos  GDP per capita with 𝑋𝑅 is 7,984 USD (=3,534.5 Pesos/USD ) 37  Exercise 𝐿𝑜𝑐𝑎𝑙 𝑃𝑟𝑖𝑐𝑒 1 𝐿𝑜𝑐𝑎𝑙 𝑃𝑟𝑖𝑐𝑒 2 𝑃𝑃𝑃 𝑋𝑅 𝐸𝑥𝑝 𝑆ℎ𝑎𝑟𝑒 1 𝑥 𝐸𝑥𝑝 𝑆ℎ𝑎𝑟𝑒 2 𝑥 𝑈𝑆 𝑃𝑟𝑖𝑐𝑒 1 𝑈𝑆 𝑃𝑟𝑖𝑐𝑒 2  The OXR between the Peruvian Nuevo Sol (PEN) and the USD is: 1 USD = 3 PEN.  What is the PPP XR? Good Expenditure Price in Peru Price in US Share Potato 10% 9 PEN/KG 3 USD/KG (1 KG) Rent 90% 1,000 PEN/Apt 2,000 USD/Apt (2 Bedroom Apt) 38  Exercise Good Expenditure Price in Peru Price in US Share Potato 10% 9 PEN/KG 3 USD/KG (1 KG) Rent 90% 1,000 PEN/Apt 2,000 USD/Apt (2 Bedroom Apt) 𝐿𝑜𝑐𝑎𝑙 𝑃𝑟𝑖𝑐𝑒 1 𝐿𝑜𝑐𝑎𝑙 𝑃𝑟𝑖𝑐𝑒 2 𝑃𝑃𝑃 𝑋𝑅 𝐸𝑥𝑝 𝑆ℎ𝑎𝑟𝑒 1 𝑥 𝐸𝑥𝑝 𝑆ℎ𝑎𝑟𝑒 2 𝑥 𝑈𝑆 𝑃𝑟𝑖𝑐𝑒 1 𝑈𝑆 𝑃𝑟𝑖𝑐𝑒 2  The official exchange rate between Peruvian Nuevo Soles (PEN) and the USD is 1 USD = 3 PEN.  What is the PPP XR? 9 𝑃𝐸𝑁/𝐾𝐺 1,000 𝑃𝐸𝑁/𝑎𝑝𝑡 𝑃𝑃𝑃 𝑋𝑅 0.1 𝑥 0.9 𝑥 3 𝑈𝑆𝐷/𝐾𝐺 2,000 𝑈𝑆𝐷/𝑎𝑝𝑡 𝑃𝑃𝑃 𝑋𝑅 0.1 𝑥 3 𝑃𝐸𝑁/𝑈𝑆𝐷 0.9 𝑥 0.5 𝑃𝐸𝑁/𝑈𝑆𝐷 0.75 𝑃𝐸𝑁/𝑈𝑆𝐷 39  Who Calculates PPP Exchange Rate in the Real World?  Calculating purchasing power requires comparing the prices of a large basket of goods that are consumed both in the local economy and in the US.  We also need to know the relative importance of each item in the basket to compute the PPP exchange rate.  This very important work is done by the International Comparison Project (ICP), housed at the World Bank.  Works with about 200 national governments to collect data on prices of thousands of goods & services to allow construction of PPP exchange rates and meaningful comparisons across countries.  See short video on Canvas/Module 2 (50th anniversary of ICP) 40  Wrap-Up: Importance of PPP  Prices for the same good or service can vary considerably across countries for two reasons:  Some goods/services are non-tradable;  Government policy (tariffs, subsidies, taxes, etc).  If we convert local incomes to a common currency (USD) using the official exchange rate we will:  NOT take these price differences into account  NOT get a good idea of the purchasing power of that income.  In order to compare standards of living across countries, we should instead convert local incomes to a common currency using the PPP exchange rate because it takes purchasing power into account.  Since non-tradables are cheaper in lower income countries, GDP per capita estimates will typically be higher for poorer countries using PPP exchange rate than official exchange rate In the U.S., $4,000 per month is not too bad… But of course that’s considering what we know about prices in the US. 41 Critical Thinking about GDP 42  Non-Marketed Goods & Services  Gross Domestic Product is the current value of all final goods and services produced in a country in a specific period of time.  Value: We use market prices because we assume that they reflect the true value of goods and services.  Two components of value:  We use market prices because we assume that they reflect the true value of goods and services.  We only include goods and services transacted in markets.  See any problems? Examples of goods or services that are not transacted in markets?  Non-Marketed Goods & Services  Many goods and services are not transacted in markets.  Subsistence food production  In our Mozambique/Tanzania research project, rural households consume about 70% of the corn they produce.  Since it’s not sold in markets, it doesn’t get counted in GDP  Many services are provided by the household  If I do the cooking at home, it doesn’t count; If I hire a cook, it counts  If I do my taxes, it doesn’t count; If I hire an accountant, it counts  If I walk the dog, it doesn’t count; If I hire a dog walker, it counts  Do you think these non-market goods are more important in rich or poor countries?  We could add the value of these goods and services by valuing them at market prices.  Environmental goods  But what about goods for which a market doesn’t even exist?  This is the case of environmental goods, such as air and water quality.  Currently, the calculation of GDP does not account for the value of environmental degradation resulting from the production of goods and services.  As a result, we over-estimate GDP.  Green Accounting (p. 64-65 in T&L) attempts to correct this, but additional innovation is strongly needed!  Does GDP measure “development”  Income is a means to an end.  What we care about are outcomes that are more directly associated with peoples’ welfare  Health, education, etc.  Let’s look at the correlations between some welfare- related indicators and GDP per capita using the World Bank’s World Development Indicators  Each dot represents a country.  A point on the red “Trendline” tells us: “On average, in countries with a given level of GDP per capita, what % of the population has access to electricity?”  The trendline is positive. What does that tell us?  What does the magnitude of the slope of the trendline tell us?  Now the trendline is negative. So, on average, infant mortality decreases with income per capita  Now I’ve used a non-linear Trendline.  What happens to the slope as GDP per capita increases?  What does this mean?  Human Development Index  You will cover HDI in sections this week  Recognizes that income is only one dimension of development – and that income is not perfectly correlated with the outcomes we directly care about.  Combines three separate development indicators:  Income  Education  Health (life expectancy)   Geometric mean definition:  If we have N different numbers;  Multiply them together and take the N’th root  HDI is the geometric mean of the three sub-indices.  Each sub-index ranges from 0 to 1, therefore, HDI ranges from 0 to 1  HDI = 0 if ANY sub-index = 0  HDI = 1 if ALL sub-indices = 1.  Excel command  I(GNI), I(E), I(LE) are in cells B2, B3, B4  Correct: “=GEOMEAN(B2, B3, B4)”  Incorrect: “=GEOMEAN(B2*B3*B4)” In the U.S., $4,000 per month is not too bad… But of course that’s considering what we know about prices in the US. 50  Geometric Mean Intuition 51 51 Comparing Income over Time 52  Comparing income over time  PPP: To make meaningful comparisons about income per capita across countries, we need to take into account price differences across countries.  Now we focus on comparisons over time within the same country.  We would like to know if people within a country are becoming better or worse off over time.  To do this, we need to keep track not just of income, but also of the purchasing power of that income.  Just like with PPP, we will need to take into price differences, but in this case over time.  We’ll work with individual-based examples…but relevant also for income per capita.  Three Key Concepts  Real versus Nominal Income  Consumer Price Index  Inflation  Clicker Quiz In 2010, Saloni earned $100,000. In 2020, Saloni earned $200,000. Between 2010 and 2020, average prices in the country tripled. Which of the following is true? A. Saloni’s nominal and real income increased B. Saloni’s nominal income increased but her real income stayed the same C. Saloni’s nominal income increased but her real income decreased D. Saloni’s nominal income decreased but her real income increased E. Saloni’s nominal and real income decreased  Clicker Quiz In 2010, Saloni earned $100,000. In 2020, Saloni earned $200,000. Between 2010 and 2020, average prices in the country tripled. Which of the following is true? A. Saloni’s nominal and real income increased B. Saloni’s nominal income increased but her real income stayed the same C. Saloni’s nominal income increased but her real income decreased (income doubled, but prices tripled so her purchasing power (real income) fell) D. Saloni’s nominal income decreased but her real income increased E. Saloni’s nominal and real income decreased  Consumer Price Index (CPI)  CPI is the cost of a “market basket of goods” in a given period relative to the cost of the same basket in a base year.  Helps us keep track of how the cost of a basket of goods and services typically purchased by households changes over time.  i.e., tracks changes in the cost of living.  CPI in initial (or base) period = 1.  CPI in next period reflects inflation:  = 1.5 if prices increased by 50%  = 1 if prices stayed the same  = 0.75 if prices fell by 25%.  Nominal vs Real Income  Nominal income is the value of income in current value of the currency.  Real income is nominal income divided by the CPI.  Allows us to compare purchasing power of income over time.  We must report the base year for the CPI  i.e., “Real income in 2010 dollars”  Back to Saloni …  In 2010, Saloni earned $100,000. In 2020, Saloni earned $200,000. Between 2010 and 2020, average prices – and the cost of the basket of goods -- in the country tripled.  Let 2010 be our base year.  Can you fill out this table? Year Nominal CPI Real Income Income (2010 $’s) 2010 $100,000 2020 $200,000  Back to Saloni …  In 2010, Saloni earned $100,000. In 2020, Saloni earned $200,000. Between 2010 and 2020, average prices – and the cost of the basket of goods -- in the country tripled.  Let 2010 be our base year.  Can you fill out this table? Year Nominal CPI Real Income Income (2010 $’s) 2010 $100,000 1 $100,000 2020 $200,000 3 $66,667 = $200,000/3  Clicker Question Year Nominal CPI Real Income Income (2010 $’s) 2010 $100,000 1 $100,000 2020 $200,000 3 $66,667 = $200,000/3 What was the rate of inflation from 2010 to 2020? A. 0% B. 50% C. 100% D. 200% E. 300%  Calculating the Rate of Inflation Year Nominal CPI Real Income Income (2010 $’s) 2010 $100,000 1 $100,000 2020 $200,000 3 $66,667 = $200,000/3  Rate of inflation between Period A and B is equal to the % change in the CPI between Period A and B  In our example: Rate of inflation between 2010 and 2020 = 100 x 100 𝑥 200%  Where do these CPI’s come from?  Basket of Goods in Pakistan Rice Restaurant Meal iPhone YEAR Quantity Price Quantity Price Quantity Price 2010 2010 100 KG 200 PKR/KG 5 meals 750 PKR/meal 0.1 phone 180,000 PKR/phone 2020 2011 100 KG 300 PKR/KG 5 meals 1,000 PKR/meal 0.1 phone 250,000 PKR/phone  CPI is the cost of a “market basket of goods” in a given period relative to the cost of the same basket in a base year.  Let 2010 be the “base year”  Let’s find the CPI in Pakistan for 2010 and 2011  Then we can calculate the annual rate of inflation in Pakistan between 2010 and 2011.  Basket of Goods in Pakistan Rice Restaurant Meal iPhone YEAR Quantity Price Quantity Price Quantity Price 2010 2010 100 KG 200 PKR/KG 5 meals 750 PKR/meal 0.1 phone 180,000 PKR/phone 2020 100 KG 300 PKR/KG 5 meals 1,000 PKR/meal 0.1 phone 250,000 2011 PKR/phone  In 2010, basket cost: 100*200 + 5*750 + 0.1*180,000 = 41,750  In 2011, basket cost: 100*300 + 5*1,000 + 0.1*250,000 = 60,000  Base year = 2010 ,  𝐶𝑃𝐼 1 , ,  𝐶𝑃𝐼 1.44 ,.  Inflation from 2010 to 2011 = 100 𝑥 44%  CPI is a big deal in recent years!!  Pandemic created major supply chain disruptions  War in Ukraine  Significant shock to global supplies of wheat and corn  Significant disruption of energy (natural gas flows)  Climate change  major weather shocks disrupt production of key food commodities (flooding in Pakistan, Heat in India, Drought in Sub-Saharan Africa, etc)  Changes in grain prices critical for developing countries because large fraction of people’s expenses go to grains  Sub-Saharan Africa depends critically on imports of wheat and maize from Ukraine.  Disruptions because of war dramatically increased food prices in SSA  millions of households suffered increased poverty and food insecurity.  Consumer Price Index (CPI)  In the U.S., CPI compiled by Bureau of Labor Statistics (BLS).  Includes about 200 categories of goods and services  More info here.  In the U.S., rate of inflation has important implications for interest rates set by Federal Reserve  Let’s take a look at the BLS’ report from September. How did the annual CPI change from Aug 2023 – Aug 2024?  Inflation seems bad…but it has been much worse! Human Development Index (time permitting) 71  Human Development Index  Geometric mean of the three sub-indices.  Each sub-index ranges from 0 to 1, therefore, HDI ranges from 0 to 1  HDI = 0 if ANY sub-index = 0  HDI = 1 if ALL sub-indices = 1. In the U.S., $4,000 per month is not too bad… But of course that’s considering what we know about prices in the US. 72  Clicker Question Burundi has the following sub-index values:  I(LE) = 0.0  I(ED) = 0.4  I(GNI) = 0.5 The HDI for Burundi is: A. 0 B. 0.3 C. 0.45 D. 0.965 In the U.S., $4,000 per month is not too bad… But of course that’s considering what we know about prices in the US. 73 Human Development Index  Calculation of a sub-index  Each sub-index takes the following form: 𝐼  Numerator  Depends on the specific value for the country  How far above the minimum is the indicator in that country?  Denominator  Same for all countries  Range between min and max  Is not based on the country’s ranking relative to other countries.  Recall specifics for each index:  Education: Simple average of EYSC & MYSA  Income: Must take logs first!  Clicker Question In 2019, Indonesia ranked 150th out of 218 countries in terms of GNI per capita. In 2021, Indonesia ranked 125th out of 218 countries in terms of GNI per capita. We can conclude that I(GNI) – the income sub-index in the HDI – increased in Indonesia between 2019 and 2021. A. TRUE B. FALSE In the U.S., $4,000 per month is not too bad… But of course that’s considering what we know about prices in the US. 76  EYSC vs MYSA Age 6 % in School 0.9 7 0.9 8 0.9  EYSC: The number of 9 0.9 10 0.9 years that a 6 year-old 11 0.7 12 0.7 child is expected to 13 0.7 complete by the age of 24. 14 15 0.5 0.5 16 0.5  Compute the % of 17 0.5 individuals enrolled in 18 0.5 19 0.1 school at each age level. 20 0.1 21 0.1  Add up those %’s to get 22 0.1 EYSC. 23 0.1 24 0.1 EYS 9.7  EYSC vs MYSA  EYSC: The number of years that a 6 year- old child is expected to complete by the age of 24.  MYSA: The average years of education completed by adults (25 and older).  What different stories are told by these two indicators?  Educational Policy in Uganda  What strikes you about education change?  Any concerns with the EYS/MYS measures?  Is universal primary or secondary education necessarily a good thing? What’s driving change in HDI in Uganda? What’s stands out in Mexico?