3.4. TRANSLATING FC FIGURES: NOMINAL RATES, PPP RATES, AND DEVIATIONS
FROM PPP 107
Figure 3.15:PPPvactual rates,HC/USDSourceBased on data fromThe Economist, May 26, 2006
3.4.2 Commodity Price Parity
A concept used in textbooks is Commodity Price Parity (CPP). It is said to hold
when translated prices for an individual good are equalized across two countries:
CPPholds ifPj,t=St×Pj,t∗, (3.11)withjreferring to an individual good, andPj(Pj∗) referring to its price at home, in
hc(abroad, infc). In fact, all the Big Mac evidence shown thus far is aboutCPP
rather thanPPP, a distinction thatThe Economisttends to gloss over.
CPPwould hold if trading were costless and instantaneous. Obviously, in reality it
does not work across the board; for commodities it is not too bad an approximation
(within the bounds created by transportation costs and the like), but for consumer
goods it is essentially a joke.
PPP in the true sense—i.e. for a bundle of goods—would clearly hold ifCPP
held for every individual good, or if deviations fromCPPwashed out after averaging
across many goods. As we have seen, this is not really the case; apparently, too
many deviations fromCPPturn out to be in the same direction, suggesting there is
a common force behind them. ForgetCPP.