Wednesday, 29 February 2012

Purchasing Power Parity

I mentioned Daily Lit some time back and the fact that I've made non-fiction selections to date.  Lately I've been getting selections from a blog, a series called MBA Mondays. I thought about pursuing a Masters in Business Administration a good while back, but decided it wasn't the road for me. The bits I've received to date have largely been about accounting, mergers & acquisitions, stock options, etc. Not that interesting or useful to a retired person like myself - and I won't claim to have understood most of it. However, there were a few posts I found particularly interesting.

One of them referred to Purchasing Power Parity.  I found this interesting because it can apply to international exchange rates, which affect me directly. My income is in USD, but most of my expenses are in GBP. I was struck by this, because I had the same idea myself, without the MBA background.    I remember making numerous comparisons about costs between the US and 'rip-off' Britain and finding much to whinge about.  For the most part anything I buy when on holiday in the US will be cheaper for me because I'm not paying the exchange fee when I drag money across to the UK.

However, this isn't really what Purchasing Power Parity is talking about, exactly.  The author, Fred Wilson, explains that this concept suggests that "a basket of goods that are traded between markets should cost the same in different markets." He gives an example of "The Big Mac Index" published annually by The Economist (lifted from Wikipedia, apparently). If the price of a Big Mac is $4 in the US and £3 in the UK, then the correct exchange rate should be 1.33 dollars per pound. It is a way of determining whether a currency is overvalued or undervalued, a difference which will eventually balance out. He goes on to give specific examples for 2008 that show that the GPB was overvalued.

How does this apply to my finances? Not very much at all as, so far as I can tell, these matters are - as they say over here - 'outwith' my control.  Someone who invested in foreign currencies might do well to be familiar with this idea, however, and it did occur to me that in the short term this information might be useful in choosing less expensive holiday destinations if going abroad.

If this sort of thing interesting you, I suspect Fred Wilson's blog A VC (Venture Capitalist) might also.

When you travel do you notice the difference in what things cost to when you're at home?

(Oh yes, and Happy Leap Year Day!  Happy Birthday to my friend Gerrie, who is something like 12 years old now...) xxx


Suburban Princess said...

I'm wondering tho...if the salaries, when exchanged are higher than in the US? Like someone who make 40K in the US...would they make 40K GBP for the same job over there?

Beryl said...

Hard to conceptualize for someone living in Oklahoma and Southern California. My money goes four times as far in Oklahoma. The US is just so big that even some of the fast food chains have cheaper prices - I can get a gallon of lemonade in Oklahoma from Chick-fil-A for $1 less than in the Southern California one.
Sad about Davy Jones - he was just 66. Last place he performed was Oklahoma. Sorry I missed it.

Shelley said...

SP, That's a good question about salaries. My impression is that they are slightly lower in the UK. When I came across I took a job for the same £££ as $$$ and although I had about the same amount of disposable income after paying bills, I was much higher up on the income scale in the UK than I was in the US. Not sure why that was. Perhaps because of the NHS or public transport the UK doesn't feel they have to pay as much salary - or it's just another one of those ways in which Brits get ripped off. Not sure.

Bery, I thought of you when Bill told me this morning about Davy Jones. It is very sad. I can well believe that the cost of living in Oklahoma is much lower than in S.Cal. It was lower than I found it in Utah as well (I nearly had heart failure at the rental prices!). The cost of living in London is nothing like it is up in Newcastle and the pay differential doesn't touch the massive amount it costs more, yet another reason I'd never choose to live there (visit, yes; live, no!)