Nominal Prices, Real Prices and Faux Prices: The Perils of Comparing Individual Prices at Purchasing Power Parity Exchange Rates
Rodney D. Ludema
Georgetown University - Department of Economics
March 20, 2010
When comparing the price of an individual good or service across different countries, it is necessary to use to a common metric. In reporting the prices of telecommunications services, the OECD converts prices into U.S. dollars using the Purchasing Power Parity (PPP) exchange rate, which takes into account how generally expensive a country is relative to the United States. This note explores the relative merits of making this type of conversion when comparing prices across countries. It argues that PPP price comparisons address a very narrow set of questions, whose implications for economic behavior and policy are quite limited. It also suggests that the most important questions for telecommunications policy are better addressed with different measures, and in such instances, the use of PPP can be misleading and counterproductive. In particular, price comparisons based on PPP conversion are unreliable indictors of consumer demand. If the PPP price of good is lower in one country than another, and this difference is due primarily to a high PPP exchange rate, then there is little reason to believe that the good will be consumed more in that country. In the case of broadband Internet, the effect of the PPP price is shown to have no causal effect on broadband penetration rates across OECD countries. A simple alternative to PPP conversion is the ratio of price to per capita income. This measure is quite easy to construct, requires no information on exchange rates, and is generally an improvement over the PPP price as a predictor of demand. Moreover, this measure has theoretical justification and provides a consistent measure of affordability.
Number of Pages in PDF File: 30
Keywords: Purchasing Power Parity, Prices, Broadband Internet
JEL Classification: F1, E3
Date posted: March 21, 2010
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