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Encyclopedia > Penn effect

The Penn effect is the economic finding that real income ratios between high and low income countries are systematically exaggerated by GDP conversion at market exchange rates. It has been a consistent econometric result for at least fifty years. Economics (deriving from the Greek words οίκω [okos], house, and νέμω [nemo], rules hence household management) is the social science that studies the allocation of scarce resources to satisfy unlimited wants. ... Income, generally defined, is the money that is received as a result of the normal business activities of an individual or a business. ... Econometrics literally means economic measurement. It is the branch of economics that applies statistical methods to the empirical study of economic theories and relationships. ...


The "Balassa-Samuelson effect" is a model cited as the principal cause of the Penn effect by neo-classical economics, as well as being a synonym of "Penn effect". The Balassa-Samuelson effect is either of two related things: The observation that consumer price levels in wealthier countries are systematically higher than in poorer ones (the Penn effect). An economic model predicting the above, based on the assumption that productivity or productivity growth-rates vary more by country in... Neoclassical economics is the grouping of a number of schools of thought in economics. ...

Contents

History

Classical economics made simple predictions about exchange rates; it was said that a basket of goods would cost roughly the same amount everywhere in the world, when paid for in some common currency (like gold)1. This is called the purchasing power parity (PPP) hypothesis, also expressed as saying that the real exchange rate (RER) between goods in various countries should be close to one. Fluctuations over time were expected by this theory but were predicted to be small and non-systematic. GOLD refers to one of the following: GOLD (IEEE) is an IEEE program designed to garner more student members at the university level (Graduates of the Last Decade). ... PPP The purchasing power parity (PPP) theory was developed by Gustav Cassel in 1920. ...


Pre-1940, the PPP hypothesis found econometric support, but some time after the Second World War, a series of studies by a Penn team documented a modern relationship: countries with higher incomes consistently had higher prices of domestically produced goods (as measured by comparable price indices), relative to prices of goods included in the exchange rate. Econometrics literally means economic measurement. It is the branch of economics that applies statistical methods to the empirical study of economic theories and relationships. ... Mushroom cloud from the nuclear explosion over Nagasaki rising 18 km into the air. ... This article is about the private Ivy League university in Philadelphia. ... CPI may stand for: Center for Public Integrity Central Port Injection, see fuel injection Centre Permanent Informatique Communist Party of India Congrès paléoethnologique international Consumer price index Cour pénale internationale This is a disambiguation page — a navigational aid which lists other pages that might otherwise share...


In 1964 the modern theoretical interpretation was set down as the Balassa-Samuelson effect, with studies since then consistently confirming the original Penn effect. However, subsequent analysis has provided many other mechanisms through which the Penn effect can arise, and historical cases where it is expected, but not found. Up until 1994 the PPP-deviation tended to be known as the "Balassa-Samuelson effect", but in his review of progress "Facets of Balassa-Samuelson Thirty Years Later" Paul Samuelson acknowledged the debt that his theory owed to the Penn World Tables data-gatherers, by coining the term "Penn effect" to describe the "basic fact" they uncovered, when he wrote: Also Nintendo emulator: 1964 (emulator). ... The Balassa-Samuelson effect is either of two related things: The observation that consumer price levels in wealthier countries are systematically higher than in poorer ones (the Penn effect). An economic model predicting the above, based on the assumption that productivity or productivity growth-rates vary more by country in... Paul Anthony Samuelson (born May 15, 1915, in Gary, Indiana) is an American neoclassical economist known for his contributions to many fields of economics, beginning with his general statement of the comparative statics method in his 1947 book Foundations of Economic Analysis. ...

The Penn effect is an important phenomenon of actual history, but not an inevitable fact of life.

Understanding the Penn effect

Most things are cheaper in poor (low income) countries than in rich ones. Someone from a "first world" country on vacation in a "third world" country will usually find their money going a lot further abroad than at home. The terms First World, Second World, and Third World were used to divide the nations of Earth into three broad categories. ... For the Jamaican reggae band, see Third World (band). ...


For instance, the same Big Mac cost $5.46 in Switzerland, and $1.49 in Russia in December 2004, at the prevailing USD exchange rate into the local currencies. To avoid confusion arising from money prices the nominal exchange rates are usually ignored, with only the 'real exchange rate' (RER) being considered. (Here, 3.66 Russian meals to one Swiss.) For other uses, see Big Mac (disambiguation). ... For other uses, see Money (disambiguation). ... In finance, the exchange rate (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies specifies how much one currency is worth in terms of the other. ...


The effect's challenge to simple open economy models

The (na├»ve form of the) purchasing power parity hypothesis argues that the Balassa-Samuelson effect shouldn't occur. A simple economic model treating Big Macs as commodity goods implies that international price competition will force Swiss, Russian, and U.S. burger prices to converge in price. The Penn effect denies this convergence; it is clear evidence that the general price level is much higher where (dollar) incomes are high, with no tendency to match the cheaper prices in poorer countries. An open economy is an economy in which people, including businesses, can trade in goods and services with other people and businesses in the international community at large. ... PPP The purchasing power parity (PPP) theory was developed by Gustav Cassel in 1920. ... Economics (deriving from the Greek words οίκω [okos], house, and νέμω [nemo], rules hence household management) is the social science that studies the allocation of scarce resources to satisfy unlimited wants. ...


How identical products can be sold at consistently different prices in different places

The law of one price says that the same item cannot sustain two different sale prices in the same market (since everyone would buy only at the lower price). By reversing this law, we can infer that different countries do not share an efficient common market from the fact that prices for the same good are different. The law of one price is an economic law stated as: In an efficient market all identical goods must have only one price. ... Economic efficiency is a general term for the value assigned to a situation by some measure designed to capture the amount of waste or friction or other undesirable economic features present. ...


If a McDonalds patron in Zurich were able to eat in an identical Moscow restaurant at quarter the price she would do so, and price competition would then equalize the Big Mac price throughout the world. Of course, someone can only eat out locally, so regional price differentials can persist; the Moscow and Zurich branches are not in competition. If the Moscow McDonalds starts giving away burgers the price in Zurich will be unaffected, since one is unlikely to dine in Moscow if starting the evening in Zurich (especially if dining at McDonalds). Location within Switzerland   Zürich[?] (German pronunciation IPA: ; usually spelled Zurich in English) is the largest city in Switzerland (population: 366,145 in 2004; population of urban area: 1,091,732) and capital of the canton of Zürich. ... For other uses, see Moscow (disambiguation). ... For other uses, see Moscow (disambiguation). ... Location within Switzerland   Zürich[?] (German pronunciation IPA: ; usually spelled Zurich in English) is the largest city in Switzerland (population: 366,145 in 2004; population of urban area: 1,091,732) and capital of the canton of Zürich. ...


The price level

Measuring 'the' price level involves looking at goods other than burgers, but most goods in a price index (CPI) show the same pattern; equivalent things tend to cost more in high income countries. Most services, perishable goods like the Big Mac, and housing cannot be purchased very far from the point of consumption (where the consumer happens to live). These items form the typical consumer shopping list, and therefore the CPI level can vary from country to country, just like the burger price. CPI may stand for: Center for Public Integrity Central Port Injection, see fuel injection Centre Permanent Informatique Communist Party of India Congrès paléoethnologique international Consumer price index Cour pénale internationale This is a disambiguation page — a navigational aid which lists other pages that might otherwise share... For other uses, see Big Mac (disambiguation). ...


The international development implications

The PPP-deviation allows rural Indians to survive on an income below the absolute subsistence level in the rich world. If the money income levels are taken as given, then ceteris paribus, the Penn effect is a very good thing. If it did not apply, millions of the world's poorest people would find that their income was below the survival threshold. However, the effect implies that the money income level disparity as measured by international exchange rates is an illusion, because these exchange rates only apply to traded goods, a small proportion of consumption. The following is a list of subsistence techniques: Hunting and Gathering, also known as Foraging freeganism involves gathering of discarded food in the context of an urban environment gleaning involves the gathering of food that traditional farmers have left behind in their fields Cultivation Horticulture - plant cultivation, based on the... Ceteris paribus is a Latin phrase, literally translated as with other things [being] the same, and usually rendered in English as all other things being equal. ...


If the genuine income differential (taking local prices into account) is exaggerated by the RER, so the real difference in the standard of living between rich and poor countries is less than GDP per capita figures would suggest. To make a more significant comparison, economists divide a country's average income by its CPI. The standard of living refers to the quality and quantity of goods and services available to people and the way these services and goods are distributed within a population. ... It has been suggested that this article be split into multiple articles accessible from a disambiguation page. ...


See also

The Economist is an English-language weekly news and international affairs publication owned by The Economist Newspaper Ltd and edited in London. ... McDonalds Big Mac purchased in Australia The Big Mac Index is an informal way of measuring the purchasing power parity (PPP) between two currencies and provides a test of the extent to which market exchange rates result in goods costing the same in different countries. ... In economics and business, the price is the assigned numerical monetary value of a good, service or asset. ... PPP The purchasing power parity (PPP) theory was developed by Gustav Cassel in 1920. ...

Footnotes

1 For instance, economists in 1949 expected that one could buy similar quantities of meat in New York for one dollar as in Tokyo for 360 Yen, the pegged nominal exchange rate at the time. It was thought that deviations from this would mostly be caused by problems of supply, and the fact that exchange rates were not allowed to float to market levels by most of the world's central banks (before the 1970s and the end of the Bretton Woods era of gold convertibility). This article is about the state. ... The United States dollar is the official currency of the United States. ... For other uses, see Tokyo (disambiguation). ... Japanese 10 yen coin (obverse) showing Phoenix Hall of Byodoin Yen is the currency used in Japan. ... A 1,000 yen note, featuring the portrait of Natsume Soseki. ... A floating exchange rate or a flexible exchange rate is a type of exchange rate regime wherein a currencys value is allowed to fluctuate according to the foreign exchange market. ... Wikipedia does not have an article with this exact name. ...


References

  • Paul A. Samuelson (1994). "Facets of Balassa-Samuelson Thirty Years Later," Review of International Economics 2(3), pp. 201-26. (Abstract defining the Penn effect). (This issue has several papers discussing the effect.)

External links


  Results from FactBites:
 
Penn effect - Wikipedia, the free encyclopedia (1255 words)
The Penn effect is the economic finding that real income ratios between high and low income countries are systematically exaggerated by GDP conversion at market exchange rates.
The "Balassa-Samuelson effect" is a model cited as the principal cause of the Penn effect by neo-classical economics, as well as being a synonym of "Penn effect".
In 1964 the modern theoretical interpretation was set down as the Balassa-Samuelson effect, with studies since then consistently confirming the original Penn effect.
  More results at FactBites »

 
 

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