- Mar 18, 2008
- 195
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- 18,680
Hey folks. I see a lot of threads in which someone will say "Dammit this card is too expensive" or "This card has a great price," then someone from another country will say "Well, we pay way more in my country so stop whining/rejoicing."
Unfortunately this is not an appropriate way of comparing prices. You can't say, for example, that because a product costs $100 in the US and $150 AUD in Australia, that the Australians are getting shafted for having to pay the equivalent of $143.01 American dollars for the same product (using a nominal exchange rate).
What you have to do is use what is called a real exchange rate (RER), which incorporates the nominal exchange rate with purchasing power differences between countries. The nominal exchange rate alone cannot capture these differences. The equation is pretty simple: P2(e)/P1, where e= the exchange rate for Country 1 into country 2 currency, P1= the price of the product in country 1, and P2= the price of the product in Country 2. If your answer is '1' , then they are on par, anything else is an actual difference in price.
So, let's say the rate of exchange between Country 1 and Country 2 is 1= 1.36. In country 1 the price for the product is 3.40 of their currency and in Country 2 it is 2.5 of their currency. Geez, seems like Country 1 is getting screwed because if you converted that price into Country 2 currency it would be 3.4*1.36= 4.624. Wow what a bad deal! Country 1 pays the equivalent of 4.624 of country 2's currency for the product, when Country 2 only pays 2.5 of their currency for the same product!
But calculate using the RER: 2.5 * 1.36 /3.4 = 1. In actuality, when taking into account purchasing power, the two country's are paying exactly the same for that product.
I know this isn't going to stop people on this board from using the old 'oh yeah, it costs this much in my country' complaint or make people start calculating real exchange rates, but I hope maybe some of you can see that a comparison using the simple nominal exchange rate is B.S. and should be interpreted accordingly.
Unfortunately this is not an appropriate way of comparing prices. You can't say, for example, that because a product costs $100 in the US and $150 AUD in Australia, that the Australians are getting shafted for having to pay the equivalent of $143.01 American dollars for the same product (using a nominal exchange rate).
What you have to do is use what is called a real exchange rate (RER), which incorporates the nominal exchange rate with purchasing power differences between countries. The nominal exchange rate alone cannot capture these differences. The equation is pretty simple: P2(e)/P1, where e= the exchange rate for Country 1 into country 2 currency, P1= the price of the product in country 1, and P2= the price of the product in Country 2. If your answer is '1' , then they are on par, anything else is an actual difference in price.
So, let's say the rate of exchange between Country 1 and Country 2 is 1= 1.36. In country 1 the price for the product is 3.40 of their currency and in Country 2 it is 2.5 of their currency. Geez, seems like Country 1 is getting screwed because if you converted that price into Country 2 currency it would be 3.4*1.36= 4.624. Wow what a bad deal! Country 1 pays the equivalent of 4.624 of country 2's currency for the product, when Country 2 only pays 2.5 of their currency for the same product!
But calculate using the RER: 2.5 * 1.36 /3.4 = 1. In actuality, when taking into account purchasing power, the two country's are paying exactly the same for that product.
I know this isn't going to stop people on this board from using the old 'oh yeah, it costs this much in my country' complaint or make people start calculating real exchange rates, but I hope maybe some of you can see that a comparison using the simple nominal exchange rate is B.S. and should be interpreted accordingly.
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