World economy.

An overview
• Time
– Inflation
• Space
– Purchasing Power Parity
• Development
– Human Development Index
– Multidimensional Poverty Index
• Measuring inequality
Space
• The variables are estimated in the currency of the
country
• Problem: The official exchange rates do not always
reflect the purchasing power of each currency.

ex: Great speculative capital movements.

• Affect exchange rate
• Do not correspond with changes in purchasing
power, at least in the short term.
 The Nominal Exchange Rate
• Nominal exchange rate: the rate at which
one country’s currency trades for another
• We express all exchange rates as foreign
currency per unit of domestic currency.
• Some exchange rates per US$
Canadian dollar: 1.13
Euro: 0.74
Japanese yen: 118.28
Mankiw, Principles of Economics
 The Real Exchange Rate
• Real exchange rate: the rate at which the g&s
of one country trade for the g&s of another
• Real exchange rate = e x P
where P*
P = domestic price
P* = foreign price (in foreign currency)
e = nominal exchange rate, i.e., foreign currency
per unit of domestic currency
 Purchasing-Power Parity (PPP)
• Purchasing-power parity:
a theory of exchange rates whereby a unit of
any currency should be able to buy the same
quantity of goods in all countries
• implies that nominal exchange rates adjust
to equalize the price of a basket of goods
across countries

https://knoema.com/yjkify/the-big-mac-index
 The Law of One Price
• Law of one price: the notion that a good
should sell for the same price in all markets
– Suppose coffee sells for $4/pound in Seattle and
$5/pound in Boston,
and can be costlessly transported.
– There is an opportunity for arbitrage,
making a quick profit by buying coffee in Seattle
and selling it in Boston.
– Such arbitrage drives up the price in Seattle and
drives down the price in Boston, until the two
prices are equal.
CHAPTER 31 OPEN
ECONOMY MACRO:
BASIC CONCEPTS
• Inflation rate greater in the EU than in the US
– 1 basket of goods = 1,25 €
– In the EU with 5 € we can buy 5/1,25 = 4 baskets of goods
– In the US with 5 $ we can buy 5 baskets of goods

• € depreciates and $ apreciates

• New exchange rate equilibrium 1,25 € = 1 $
– In the EU, 5 € can buy 5/1,25 = 4 baskets of goods
– In the US, 4 $ ( 5€/1,25$) can buy 4 baskets of goods

8
 PPP and Its Implications
P*
• PPP implies that the nominal e =
P
exchange rate between two countries
should equal the ratio of price levels.
• If the two countries have different inflation rates, then
e will change over time:
– If inflation is higher in Mexico than in the U.S.,
then P* rises faster than P, so e rises –
the dollar appreciates against the peso.
– If inflation is higher in the U.S. than in Japan, then
P rises faster than P*, so e falls –
the dollar depreciates against the yen.
 Limitations of PPP Theory
Two reasons why exchange rates do not always adjust to
equalize prices across countries:
• Many goods cannot easily be traded
– Examples: haircuts, going to the movies
– Price differences on such goods cannot be
arbitraged away
• Foreign, domestic goods not perfect substitutes
– E.g., some consumers prefer Toyotas over Ford, or
vice versa
– Price differences reflect taste differences
 Inflation & Depreciation in a Cross-Section
of 31 Countries
10,000.0
Ukraine
1,000.0
Avg annual Romania
Brazil
depreciation 100.0
Argentina
relative to
US dollar 10.0 Mexico
1993-2003 Canada
(log scale) 1.0 Kenya
Japan
0.1
0.1 1.0 10.0 100.0 1,000.0
Avg annual CPI inflation
1993-2003 (log scale)
 GDP per capita in 2011, US = 1

Recasting international income differences: The next-generation Penn World Table

Robert C Feenstra, Robert Inklaar, Marcel Timmer 02 September 2013
• Population
• Economic indicators
• International trade
• Quality of life
 Human Development Index (HDI)

• Economic growth vs development

• Health
• Education
• Standard of living
 Human Development Index (HDI)

• The health dimension is assessed by life expectancy

at birth
• The education dimension is measured by mean of
years of schooling for adults aged 25 years and more
and expected years of schooling for children of
school entering age.
• The standard of living dimension is measured by
gross national income per capita
 Human Development Index

http://hdr.undp.org/en/content/2019-human-development-index-ranking
http://hdr.undp.org/en/content/human-development-index-hdi
Multidimensional Poverty Index (MPI)
• The Multidimensional Poverty Index (MPI)
identifies multiple deprivations at the
household level in
• Health
• Education
• Standard of living
Multidimensional Poverty Index (MPI)

http://hdr.undp.org/en/2019-MPI
 Happiness/wellbeing
• Health • Log GDP per capita
• Social support
• Money
• Healthy life
• Love expectancy at birth
• Generosity
• Freedom to make life
choices
• Perceptions of
corruption
 • Log GDP per capita
• Social support (or having someone to count
on in times of trouble).
Answer to the Gallup World Poll (GWP) question “If
you were in trouble, do you have relatives or friends
you can count on to help you whenever you need
them, or not?

https://s3.amazonaws.com/happiness-report/2019/WHR19.pdf page. 22
• Health. Life expectancy at birth
• Generosity
“Have you donated money to a charity
in the past month?” GWP question
• Freedom to make life choices
“Are you satisfied or dissatisfied
with your freedom to choose what you do
with your life?” GWP question
• Perceptions of corruption
“Is corruption widespread throughout the
government or not” GWP question
“Is corruption widespread within businesses or
not?” GWP question
 Taken together, these six variables explain almost
three-quarters of the variation in national annual
average ladder scores among countries, using data
from the years 2005 to 2015

Changes in Happiness

• https://s3.amazonaws.com/happiness-
report/2019/WHR19.pdf page. 34
 Measuring inequality

• Lorenz curve
• Gini index
 Lorenz curve
• x-axis. cumulative percentage of households
• y-axis. cumulative percentage of wealth
• the distribution is ordered from the smallest
through to the largest
• line of absolute equality (slope of 45 degrees).
• The more unequal the society is, the further
the Lorenz Curve will deviate away from the
line of absolute equality.
questions:
• what proportion of wealth is owned by the
poorest 10 (20, …) percent of the population?
Lorenz Curve
Lorenz Curve
 Gini Coefficient
• It is the ratio of the area between the Lorenz
Curve and the line of absolute equality
(numerator) and the whole area under the line of
absolute equality (denominator).

Gini Coefficient = C/0AB.

• The extreme values of the Gini Coefficient are
0 and 1.
• These are often presented in statistical
publications as percentages
Economic growth
• https://www.imf.org/external/datamapper/NGDP_RPCH@WE
O/OEMDC/ADVEC/WEOWORLD
http://veimages.gsfc.nasa.gov/1438/earth_lights.gif
Economic Growth 1500-2000
 The importance of growth rates
• Small increases in annual growth rates, make big
differences over time

• Annual growth rate

• 2,1 %. GDP pc * 8 in 100 yrs
• 2,6 % GDP pc * 13 in 100 yrs
 Rule of 70. How many years it
takes to double
Annual % GDP growth Number of years required to double
1 70
2 35,0
3 23,3
4 17,5
5 14,0
6 11,7

• 1950 - 1975, GDP pc in India 1,8% annual average

GDPpc doubles in 39 yrs ( 70/1.8=38,8)
• 1975- 2000, GDP pc in China 6 % annual average
GDPpc doubles in 12 yrs ( 70/6=11,6)
 1820-1870: 0,5% anual
1870-1950: 1,1% anual
1950-1998: 2,1% anual
• Greater differences
between countries
• Changes in the
relative positions of
countries
 Many questions

• Big differences
• What are the main drivers of economic growth?
• What is productivity?