1 Purchasing Power of Parity What does $2 buy?

2 Living on $ 2 a day Nearly half the worlds population lives on less than $2 a day.  Note: we will refer to the “$” sign as US Dollars What does this mean? That is, what does $2 buy you? To better comprehend what this means, we’ll use Mumbai India as an example.  Nearly 75% of the population in Mumbai, India lives on less than $2 a day.

3 What can you buy with your Rupees? Suppose you live in Mumbai, India. Additionally, you are told that you earn 92 Indian Rupees per day.

4 How do we interpret 92 Rupees? What does this salary mean to you?  Probably not much. Why?  How much goods & services does 92 Indian Rupees buy you?

5 Purchasing Power of Parity & Nominal Exchange Rates As it turns out, 92 Rupees is equivalent to $2 US dollars. As of August 6th, 2010 But that’s not the end of the story  What we have done is a simple nominal exchange rate.  What we need is a purchasing power of parity index to better understand what $2 or 92 Rupees buys us in Mumbai India.

6 Purchasing Power of Parity (PPP) Index A purchasing power of parity index helps us to compare the cost of a typical basket of goods and services [we] consume to the cost of that basket in a different country. For example: A 3-mile/5km taxi ride:  In New York: $10.25  In Mumbai India: $1.37

7 Relative Purchasing Power Why is a taxi ride so much “cheaper” in India vs. New York? Without getting too far off-track, part of the reason is that services tend to be cheaper in countries that are labor abundant relative to capital abundant countries. So far we’ve just looked at taxi rides. Suppose we examine a more diverse basket of goods and services.

8 Price comparison of a typical basket of Western goods/services. Using a weighted basket of 122 goods and services. What’s meant by weighted?  Well, suppose you spend 40% of your income on housing and 5% on electronics.  Therefore, prices of housing will affect you more than electronics and a weighted basket accounts for this.

9 What does a typical monthly basket cost? Using a basket of 122 goods & services:  New York: $2,969  Mumbai, India: $916 It looks much cheaper to live in Mumbai India than New York. In fact, it’s about 31% cheaper and if you could take your $2,969 spent on goods & services over to Mumbai, you could purchase much more.

10 Here’s the Catch Remember that 75% of the population in India lives on less than $2 a day - That is, less than $60 per month. In other words, 75% of the population in Mumbai India lives on what you could buy for $194 per month in New York! [($60/$916)] x $2,969 = $194

11 The cost of a food basket per month. Food Prices:  New York: $571  Mumbai, India: $153 Again, it looks cheaper in Mumbai India. However, 75% of people living in Mumbai on $2 a day could spend their entire income on food and still only have 40% of the daily food intake compared to that of a typical individual in New York  ($60 / $153)x100 = 40%. To put this in a relative perspective: This would be equivalent to someone living in New York, spending their entire income on just food (no housing, clothing, entertainment etc.) and still just be able to consume 40% of the amount of food that the average New Yorker lives on.  [($60/$153)] x $571 = $224

12 Why do workers in developing nations earn so much less than those in developed nations? Productivity Output  The value of output per hour per worker. There are many factors that contribute to productivity.  Physical Capital  Human Capital  Technology There are also many reasons as to why these factors are lacking in developing nations.

13 When workers become more productive, the higher the value of their output per hour worked and subsequently, the wages that they can command. Average minutes of work required to buy: 1 Kg of Rice  New York: 8 minutes  Mumbai India: 37 minutes  4.6 the amount of time in Mumbai relative to New York. An individual in Mumbai must work almost 5 times longer to buy a kg. of rice vs. someone in New York. 1 ipod Nano (8 GB)  New York: 9 hours  Mumbai India: 177 hours  19.6 the amount of time in Mumbai relative to New York.

14 How can we help to improve productivity & thus wages? Adding more Physical Capital: Your fundraising efforts during the $2 a day challenge can help those in developing nations obtain a loan. These loans can be used to buy new equipment for an entrepreneur's business. This new equipment can make the business more productive.

15 Improving Skills Adding more Human Capital (knowledge) The equipment that is purchased may also be operated by an employee, improving on-the-job skills. These skills can be taught and used by the employee elsewhere making him or her more productive.

16 Example: The Shirt Maker Suppose you live in Mumbai India and make shirts for a living. To make a shirt, you must buy cloth, and using a needle and thread, sew together the shirt. For simplicity, we’ll assume this process takes you 1-hour.  That is, you make 1 shirt an hour

17 How can Physical Capital help the shirt maker? Suppose that you apply for a loan to purchase a sewing machine. With the sewing machine, you can now make 2 shirts per hour. Therefore, the value of your output per hour worked has doubled!

18 How can Human Capital help the shirt maker? Given that you are now twice as productive as before, you can maintain the same standard of living by allocating half the amount of time to work as before. With this extra time, you decide to learn how to silkscreen.  The silkscreen process will allow you to add designs and colors to your shirts. This improvement in knowledge makes the value of your output per hour worked even greater.

19 The Shirt Maker’s Standard of Living. Remember that we said an individual in Mumbai, must work 5 times longer than an individual in New York to buy the same kg. of rice. After the improvement in both Physical Capital and Human Capital, the individual in Mumbai can now consume more “goods” (rice in our case) working the same amount of hours.

20 So where do you come in? By participating in The Two Dollar Challenge, you’re helping create awareness about global poverty and the challenges faced. Through fundraising efforts, you’re helping to grow the level of physical and human capital available to those in developing nations.