Why is it so expensive to live in London?
The richer the country, the higher the cost of living. Prices that you see in supermarkets and cafes of London generally are higher (in nominal terms) than those in Baku or Gaborone.
(a) (10 rp) For different goods and services, this effect is different. Provide examples of goods or services which typically cost almost the same across the world. Provide examples with high price differences. Explain.
Ответ
Goods that are easier to trade across the board are more likely to cost roughly the same (economists call it the law of one price). Otherwise, exporters and importers will find profit opportunities and drive the prices closer together. A typical example is consumer electronics.
On the other hand, non-tradable goods and services must be produced locally and cannot be easily exported and imported. Food, most services (haircuts, taxi, etc.) are examples of it.
Relevant economic terms (not graded): law of one price, arbitrage.
(b) (10 rp) Provide a verbal model to explain this phenomenon: why in more developed countries (with greater labor productivity), certain goods are likely to be more expensive than in developing countries.
Ответ
Technological advancement increases productivity in tradable sectors (like producing electronics) more than in non-tradable and labor-intensive (like hairdressing). The wages of tradable sector workers go up.
Demand side: Tradable sector workers have high wages so their demand is less elastic for non-tradable services. This increases their prices.
Supply side: Tradable and non-tradable sectors within a country are connected through the labor market: higher (real) wages in the tradable sector in advanced countries attract workers. So, the non-tradable sector wages also rise above the level of developing countries, even though the productivity of hairdressers across the world is roughly the same. Increased salaries lead to an increase in prices.
Relevant economic terms (not graded): Balassa-Samuelson effect, Baumol's cost disease.
(c) (10 rp) What approach do economists use to account for these differences and compare gross domestic products between countries? If we calculate GDPs per capita utilizing this approach, will we observe more or less between-country inequality?
Ответ
This concept is called purchasing power parity (PPP). Similar baskets of goods and their price difference between countries are used to adjust the nominal exchange rate and consider relative prices. Since similar baskets are more expensive in developed countries (with higher GDP), PPP-adjustment will decrease the difference of nominal GDPs. Less between-country inequality will be observed.