PRINCIPLES OF ECONOMICS – 9TH Edition N.

GREGORY MANKIW

Ten Principles of Economics

• Economy, “oikonomos” (Greek): “One who manages a household”. Households and economies have much in common
• A household faces many decisions: Allocate scarce resources taking into account: ability, effort, desire
• Society faces many decisions: Allocate resources and output
Resources are scarce
• Scarcity: the limited nature of society’s resources. Society has limited resources and therefore cannot produce all the goods
and services people wish to have.
• Economics: The study of how society manages its scarce resources
• Economists study: How people make decisions like Work, buy, save, invest. How people interact with one another. The
forces and trends that affect the economy as a whole such as Growth in average income, Fraction of the population that
cannot find work, Rate at which prices are rising

How people make decisions

Principle 1: People face trade-offs
Principle 2: The cost of something is what you give up to get it
Principle 3: Rational people think at the margin
Principle 4: People respond to incentives
How people interact
Principle 5: Trade can make everyone better off
Principle 6: Markets are usually a good way to organize economic activity
Principle 7: Governments can sometimes improve market outcomes
How the economy as a whole works
Principle 8: A country’s standard of living depends on its ability to produce goods and services
Principle 9: Prices rise when the government prints too much money
Principle 10: Society faces a short-run trade-off between inflation and unemployment

How People Make Decisions

Principle 1: People Face Trade-offs
• “There ain’t no such thing as a free lunch”: To get something that we like, we usually have to give up something else that
we also like
• Making decisions: Requires trading off one goal against another: to study one more hour, give up one hour of TV
• Trade-offs: Students: how to allocate time. Parents: how to spend income
• Society faces trade-offs: National defense and consumer goods (guns and butter). Clean environment and high level of
Income. Efficiency and equality.
• Efficiency: Society is getting the maximum benefits from its scarce resources. The size of the economic pie.
• Equality: Distributing economic prosperity uniformly among the members of society. How the pie is divided into
individual slices.
• Efficiency and Equality trade-off: Public policies aimed at equalizing the distribution of economic well-being such as
Welfare system, Unemployment insurance, Individual income tax, Achieve greater equality but reduce efficiency.
• Recognizing that people face trade-offs: Does not by itself tell us what decisions they will or should make.

Principle 2: The Cost of Something Is What You Give Up to Get It

• People face trade-offs; making decisions: Compare costs with benefits of alternatives Need to include opportunity costs
• Opportunity cost: Whatever must be given up to obtain some item

Principle 3: Rational People Think at the Margin

• Rational people: Systematically and purposefully do the best they can to achieve their objectives. Given the available
opportunities
• Marginal changes: Small incremental adjustments to a plan of Action
• Rational decision maker: Make decisions by comparing marginal benefits and marginal costs. Take action only if: Marginal
benefits > Marginal Costs
• Why is water so cheap, while diamonds are so expensive?
–Water – needed to survive
–Diamonds – not a necessity
–A person’s willingness to pay for a good: Based on the marginal benefit that an extra unit of the good would yield. The
marginal benefit depends on how many units a person already has.

Principle 4: People Respond to Incentives

• Incentive: Something that induces a person to act. Higher price(Buyers consume less; Sellers produce more). Public policy
(Change costs or benefits, Change people’s behavior, Can have unintended consequences)
• Seat belt law alters a driver’s cost–benefit calculation (Sam Peltzman, 1975): Seat belts make accidents less costly (reduce
the likelihood of injury or death) reduce the benefits of slow, careful driving. People drive faster and less carefully: Larger
number of accidents. Net result: little change in the number of driver deaths and an increase in the number of pedestrian
deaths.

How People Interact

Principle 5: Trade Can Make Everyone Better Off
• Trade: Allows each person to specialize in the activities he or she does best. Enjoy a greater variety of goods and services
Principle 6: Markets Are Usually a Good Way to Organize Economic Activity
• Communist countries, central planning: Government officials (central planners) are in the best position to allocate the
economy’s scarce resources (What goods and services were produced, How much was produced, Who produced and
consumed these goods and Services)
• Market economy, allocation of resources: Through decentralized decisions of many firms and households as they interact
in markets for goods and services. Guided by prices and self-interest.
• Market economies: No one is looking out for the economic well-being of society as a whole. Have proven remarkably
successful in organizing economic activity to promote overall economic well-being
• Adam Smith’s “invisible hand”: Households and firms interacting in markets (Act as if they are guided by an “invisible
hand”, Leads them to desirable market outcomes). Corollary: Government intervention (Prevents the invisible hand’s ability
to
coordinate the decisions of the households and firms that make up the economy)
• Strict controls in the market for taxis: Regulation of insurance and safety. Limit entry into the market: limited number of
taxi medallions or permits. May determine the prices that taxis are allowed to charge. To keep unauthorized drivers off the
streets and to prevent all drivers from charging unauthorized prices.
• Uber, launched in 2009: App for smartphones that connects passengers and drivers. Uber cars do not roam the streets
looking
for taxi-hailing pedestrians (Not taxis; not subject to the same regulations,but they offer much the same service). Often
charge less than taxis. Drivers raise their prices significantly when there is a surge in demand.
• Not everyone is fond of Uber: Traditional taxi drivers
• Economists love Uber: Increase consumer well-being
• Surge pricing: Increases the quantity of car services supplied when they are most needed. Allocate the services to those
consumers who value them most highly

Principle 7: Governments Can Sometimes Improve Market Outcomes

• We need government: –Enforce rules and maintain institutions that are key to a market economy –Need institutions to
enforce property rights –Promote efficiency, avoid market failure –Promote equality, avoid disparities in economic
wellbeing
• Property rights: Ability of an individual to own and exercise control over scarce resources
• Market failure: –Situation in which the market left on its own fails to allocate resources efficiently –Externalities –Market
power
• Externality: – Impact of one person’s actions on the well-being of a bystander –Pollution
• Market power: Ability of a single economic actor (or small group of actors) to have a substantial influence on market prices
• Disparities in economic wellbeing: Market economy rewards people (According to their ability to produce things that other
people are willing to pay for). Government intervention, public policies (Aim to achieve a more equal distribution of
economic well-being, May diminish inequality, Process far from perfect)

Principle 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services
• Large differences in living standards: Among countries )Average annual income, 2014: $55,000 (U.S.); $17,000 (Mexico);
$13,000 (China); $6,000 (Nigeria). Over time: In the U.S. incomes have historically grown about 2% per year
• Explanation: differences in productivity
• Productivity: –Quantity of goods and services produced from each unit of labor input -Higher productivity –Growth rate of
nation’s productivity to determines growth rate of its average income.

Principle 9: Prices Rise When the Government Prints To Much Money

• Inflation: An increase in the overall
level of prices in the economy
• Causes for large or persistent inflation: Growth in quantity of moneyand Value of money falls

Principle 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment
• Short-run effects of monetary injections: –Stimulates the overall level of spending and the demand for goods and services
–Firms raise prices, hire more workers, produce more goods and services –Lower unemployment
• Short-run trade-off between unemployment and inflation: –Over a period of a year or two, many economic policies push
inflation and unemployment in opposite directions –Key role – analysis of business cycle.
• Business cycle
–Fluctuations in economic activity
–Such as employment and production
 MEASURING A NATION’S INCOME
• Microeconomics: Study of how households and firms (• Make decisions • Interact in markets)
• Macroeconomics: Study of economy-wide phenomena (• Including inflation, unemployment, and economic growth)

Economy’s Income and Expenditure

• Gross Domestic Product (GDP): Measures the total income of everyone in the economy. Measures the total expenditure on
the
economy’s output of goods and services.
• For an economy as a whole: Income must equal expenditure
• Circular-flow diagram – assumptions: –Markets (• Goods and services • Factors of production) –Households (• Spend all
of their income • Buy all goods and services) –Firms (• Pay wages, rent, profit to resource owners)

The Measurement of GDP

• Gross domestic product (GDP): –Market value of all final goods and services –Produced within a country – In a given
period of time
• “GDP is the market value…”: Market prices – reflect the value of the goods
• “… of all…”: All items produced in the economy (• And sold legally in markets) –Excludes most items (• Produced and
sold illicitly • Produced and consumed at home)
• “… final…”: Value of intermediate goods is already included in the prices of the final goods
• “… goods and services…”: Tangible goods & intangible services
• “… produced…” : Goods and services currently produced
• “… within a country…”: Goods and services produced domestically (• Regardless of the nationality of the producer)
• “… in a given period of time”: A year or a quarter
• Identity: Y = C + I + G + NX
• Y = GDP
• C = consumption
• I = investment
• G = government purchases
• NX = net exports
• Consumption, C: Spending by households on goods and services (• Goods: durable goods, nondurable goods • Services:
intangibles, spending on education) –Exception: purchases of new housing
• Investment, I: Purchase of (capital) goods that will be used to produce other goods and services in the future (• Business
capital: business structures, equipment, and intellectual property products • Residential capital: landlord’s apartment
building; a homeowner’s personal residence • Inventory accumulation)
• Government purchases, G: -Government consumption expenditure and gross investment –Spending on goods and services
–By local, state, and federal governments –Does not include transfer payments
• Net exports, NX = Exports - Imports
–Exports • Spending on domestically produced goods by foreigners
– Imports • Spending on foreign goods by domestic residents

2015, GDP of the U.S.: almost $18 trillion

• GDP per person = $55,822
–Consumption = $38,218 per person (68% of GDP)
– Investment = $9,402 per person
–Government purchases = $9,919 per person
–Net exports = - $1,657 per person • Americans spent more on foreign goods than foreigners spent on American goods

Real Versus Nominal GDP

• Total spending rises from one year to the next: –Economy — producing a larger output of goods and services –And/or
goods and services are being sold at higher prices
• Nominal GDP: –Production of goods and services –Valued at current prices
• Real GDP: –Production of goods and services –Valued at constant prices –Designate one year as base year –Not affected
by changes in prices
• For the base year: –Nominal GDP = Real GDP

• The GDP deflator: Ratio of nominal GDP to real GDP times 100 is 100 for the base year. –Measures the current level of
prices relative to the level of prices in the baseyear –Can be used to take inflation out of nominal GDP (“deflate” nominal
GDP)
• Inflation: Economy’s overall price level is rising
• Inflation rate: Percentage change in some measure of the price level from one period to the next

• The GDP data: –Real GDP grows over time (• The real GDP of the U.S. economy in 2015 was more than four times its
1965 level • Growth – average 3% per year since 1965) –Growth is not steady (GDP growth interrupted by recessions)
• Recession: –Two consecutive quarters of falling GDP –Real GDP declines –Lower income –Rising unemployment
–Falling profits – Increased bankruptcies

GDP
• GDP – “the single best measure of the economic well-being of a society”
–Economy’s total income
–Economy’s total expenditure
–Larger GDP (• Good life, better healthcare • Better educational systems)
–Measure our ability to obtain many of the inputs into a worthwhile life
• GDP – not a perfect measure of well- being: –Doesn’t include (Leisure, Value of almost all activity that takes place outside
markets, Quality of the environment) –Nothing about distribution of income
• Rich countries — higher GDP per person: –Better (Life expectancy, Literacy, Internet usage)
• Poor countries — lower GDP per person: –Worse (• Life expectancy • Literacy • Internet usage
• Low GDP per person
–More infants with low birth weight
–Higher rates of infant mortality
–Higher rates of maternal mortality
–Higher rates of child malnutrition
–Less common access to safe drinking water
–Fewer school-age children are actually in School
• Low GDP per person
–Fewer teachers per student
–Fewer televisions
–Fewer telephones
–Fewer paved roads
–Fewer households with electricity

Pendekatan PDB Indonesia

1. Menurut Pendekatan Produksi
PDRB adalah jumlah nilai tambah atas barang dan jasa yang dihasilkan oleh berbagai unit produksi di wilayah suatu negara
dalam jangka waktu tertentu (biasanya satu tahun). Unit-unit produksi tersebut dalam penyajian ini dikelompokkan menjadi
9 lapangan usaha (sektor) yaitu :
- Pertanian, Peternakan, Kehutanan dan Perikanan
- Pertambangan dan Penggalian
- Industri Pengolahan
- Listrik, Gas dan Air Bersih
- Konstruksi
- Perdagangan, Hotel dan Restoran
- Pengangkutan dan Komunikasi
- Keuangan, Real Estate dan Jasa Perusahaan
- Jasa-jasa termasuk jasa pelayanan pemerintah. Setiap sektor tersebut dirinci lagi menjadi sub-sub sektor.

2. Menurut Pendekatan Pendapatan

PDRB merupakan jumlah balas jasa yang diterima oleh faktor-faktor produksi yang ikut serta dalam proses produksi di suatu
negara dalam jangka waktu tertentu (biasanya satu tahun). Balas jasa faktor produksi yang dimaksud adalah upah dan gaji,
sewa tanah, bunga modal dan keuntungan; semuanya sebelum dipotong pajak penghasilan dan pajak langsung lainnya.
Dalam definisi ini, PDRB mencakup juga penyusutan dan pajak tidak langsung neto (pajak tak langsung dikurangi subsidi).

3. Menurut Pendekatan Pengeluaran

PDRB adalah semua komponen permintaan akhir yang terdiri dari : pengeluaran konsumsi rumah tangga dan lembaga
swasta nirlaba, pengeluaran konsumsi pemerintah, pembentukan modal tetap domestik bruto, perubahan inventori, dan,
ekspor neto (ekspor neto merupakan ekspor dikurangi impor).

MEASURING THE COST OF LIVING

The Consumer Price Index (CPI): Measure of the overall level of prices, measure of the overall cost of goods and services
(bpught by a typical consumer), computed and reported every moth by the Bureau of Labor Statistics
Calculating CPI
1. Fix the basker : which prices are most important to the typical consumer, different weight
2. Find the prices ; at the each point in time
3. Compute the basket’s cost : same basket of goods, isolate the effect of price changes
4. Chose a base year and compute the CPI : base year=benchmark
Price of basjet of goods and services in current year, divided by price of basket in base year, times 100
5. Compute the inflation rate

6. Inflation rate : percentage change in the price index from the preceding period
7. Core CPI : measure of the overall cost of consumer goods and services excluding food and energy
8. Producer price index, PPI : measure of the cost of a basket of goods and services bought by firms, changes in PPI
are often thought to be useful in predicting changes in CPI

9. Problems in measuring the cost of living :

Substitution bias : prices do not change proportionately, consumers substitute toward goods that have become
relatively less expensive
Introduction of New Goods : more variety of goods
Unmeasured quality change :changes in quality
GDP Deflator Versus CPI
1. GDP Deflator : Ratio of nominal GDP to real GDP, reflects prices of all goods and services produces domestically
2. CPI :reflects prices of goods and services bought by consumers
 3. GDP Deflator ; compares the price of currently produced goods and services, to the price of the same goods and
services in the base year
4. CPI : compares price of a fixed basket of goods and services, to the price of the basket in the base year
Correcting Economic Variables
1. Dollar figures from different times

A price index such as the CPI: measures the price level and thus determines the size of the inflation correction
The cost of living varies: not only over time, but also over geography
Regional price parities: measure variation in the cost of living from state to state
Regional differences explained by: prices of goods (small part), prices of services (larger part), hosuing services
(persistently large)
2. Indexation
Automatic correction by law or contract of a dollar amount for the effect of inflation, COLA: Cost of living
allowance
Real and Nominal Interest Rates
1. Nominal interest rate: interest rate as usually reported without a correction for the eefcts of inflation
2. Real interest rate: interest rate corrected for the effects of inflation
= nominal interest rate – inflation rate
3. Nominal interest rate: always exceeds the real interest rate, U.S. economy has experienced rising consumer prices
inn every year
4. Inflation is variable: real and nominal interest rated do not always move together
5. Periods of deflation: real interest rate exceeds the nominal interest rate

OPEN-ECONOMY MACROECONOMICS: BASIC CONCEPTS

Basic Concepts
• Closed economy: Economy that does not interact with other economies in the world
• Open economy: Economy that interacts freely with other economies around the world • Interacts with other economies: It
buys and sells goods and services in world product markets. It buys and sells capital assets such asstocks and bonds in world
financial markets
The Flow of Goods
• Exports: Goods and services that are produced domestically and sold abroad
• Imports: Goods and services that are produced abroad and sold domestically
• Net exports (Trade balance): Value of a nation’s exports minus the value of its imports
• Trade surplus (Positive net exports): Exports are greater than imports
• The country sells more goods and services: abroad than it buys from other countries
• Trade deficit (Negative net exports): Imports are greater than exports
• The country sells fewer goods and services: abroad than it buys from other countries
• Balanced trade: Exports equal imports
• Factors that might influence a country’s exports, imports, and net exports:
– Tastes of consumers for domestic & foreign goods
– Prices of goods at home and abroad
– Exchange rates at which people can use domestic currency to buy foreign currencies
• Factors that might influence a country’s exports, imports, and net exports:
– Incomes of consumers at home and abroad
–Cost of transporting goods from country to country
–Government policies toward international trade
• Increasing importance of international trade
and finance: 1950s, imports and exports: 4-5% of GDP, Recent years – about three times that level
• Largest trading partners, 2018 (imports and
exports combined): China Followed by Canada, Mexico, Japan, Germany, South Korea, the United Kingdom
• Increase in international trade: Improvements in transportation
• Cargo ships, long-distance jets, wide-body jet: Advances in telecommunications
• Telephone, e-mail: Technological progress
• Light and easy to transport goods, Government’s trade policies such as NAFTA, GATT
The Flow of Financial Resources
• Net capital outflow (net foreign investment): Purchase of foreign assets by domestic residents, Foreign direct investment
and Foreign portfolio investment, Minus the purchase of domestic assets by foreigners
• Variables that influence net capital outflow: Real interest rates paid on foreign assets, Real interest rates paid on domestic
Assets, Perceived economic and political risks of holding assets abroad, Government policies that affect foreignownership of
domestic assets
• Net exports (NX): Imbalance between a country’s exports and its imports
• Net capital outflow (NCO): Imbalance between Amount of foreign assets bought by domestic residents And the amount of
domestic assets bought by foreigners
• Identity: NCO = NX
• When NX > 0 (trade surplus): Selling more goods and services to foreigners yhan it is buying from them. From net sale of
goods and services, Receives foreign currency, Buy foreign assets, Capital is flowing out of the country: NCO > 0
A US computer programmer sold a software to a Japanese firm for 10,000 yen
• Net export > 0 • The programmer has 10,000 yen and she
has these possibilities
1. Keep it in the wallet; NCO>0
2. Buy Japanese stock; NCO>0
3. Buy Japanese TV; NCO>0
4. Save it in a local bank; NCO>0
• When NX < 0 (trade deficit): Buying more goods and services from foreigners than it is selling to them
–The net purchase of goods and services
• Needs financed
• Selling assets abroad
• Capital is flowing into the country: NCO < 0
Saving and Investment
• Open economy: Y = C + I + G + NX
• National saving: S = Y – C – G
• Y – C – G = I + NX
• S = I + NX
• NX = NCO
• S = I + NCO
• Saving = Domestic investment + Net capital outflow
International Flows
• Trade surplus: Exports > Imports
• Net exports > 0
• Y > Domestic spending (C+I+G)
•S>I
• NCO > 0
• Trade deficit: Exports < Imports
• Net exports < 0
• Y < Domestic spending (C+I+G)
•S<I
• NCO < 0
• Balanced trade : Exports = Imports
• Net exports = 0
• Y = Domestic spending (C+I+G)
•S=I
• NCO = 0

• The United States: “The world’s largest debtor”

– Borrowing heavily in world financial markets during the past three decades to finance large trade deficits
• Before 1980: National saving and domestic investment were close, small net capital outflow (between – 1 and 1 % of GDP)
• After 1980: National saving – often falling below domestic investment, Sizable trade deficits, Substantial inflows of
capital, Net capital outflow is often a large negative number
• Unbalanced fiscal policy: 1980 to 1987: Flow of capital into the U.S. declines from 0.5 to 3.1% of GDP (2.6 percentage
point
change) due to a fall in national saving of 3.2 percentage points • Due to decline in public saving • Increase in the
government budget deficit • President Ronald Reagan cut taxes and increased defense spending
• An investment boom: 1991 to 2000: Increase flow of capital (from 0.5 to 3.9% of GDP), Saving increased, Government
budget surplus, Investment increased from 13.4 to 17.8% of GDP
• An economic downturn and recovery: 2000 to 2018: 2000-2009, saving and investment fell by about 6 percentage points.
Investment: tough economic times made capital accumulation less profitable
Saving: government began running extraordinarily large budget deficits
2009-2018, as the economy recovered, saving and investment increased by about 4 percentage points
• Are these trade deficits and international capital flows a problem for the U.S. economy?
– No easy answer to this question
• Trade deficit induced by a fall in saving (1980s): The nation is putting away less of its income to provide for its future. No
reason to deplore the resulting trade deficits, better to have foreigners invest in the U.S. economy than no one at all
• Trade deficit induced by an investment boom (1990s): Economy is borrowing from abroad to finance the purchase of new
capital goods (For good return on investment - the economy should be able to handle the debts that are being accumulated
and For lower return on investment - debts will look less desirable)

Trade Balances and Trade Negotiations “A typical country can increase its citizens’ welfare by enacting policies that would
increase its trade surplus (or decrease its trade deficit).”
“An important reason why many workers in Michigan and Ohio have lost jobs in recent years is because US presidential
administrations over the past 30 years have not been tough enough in trade negotiations.”
Prices for International Transactions
• Nominal exchange rate: Rate at which a person can trade currency of one country for currency of another. Example:
Exchange rate = 80 yen per dollar
• Appreciation (strengthen): Increase in the value of a currency as measured by the amount of foreign currency it can buy,
buy more foreign currency.
• Example: dollar appreciation: Exchange rate (old) = 80 yen per dollar, Exchange rate (new) = 90 yen per dollar, (Yen
depreciation)
• Depreciation (weaken): Decrease in the value of a currency As measured by the amount of foreign currency it can buy, buy
less foreign currency. Example: dollar depreciation: Exchange rate (old) = 80 yen per dollar, Exchange rate (new) = 70 yen
per dollar, (Yen appreciation)
• Real exchange rate: Rate at which a person can trade goods and services of one country for goods and services of another

• Real exchange rate = (e x P) / P*

Using price indexes
e: nominal exchange rate between the U.S. dollar and foreign currencies
P: price index for U.S. basket
P*: price index for foreign basket
• Depreciation (fall) in the U.S. real exchange rate: U.S. goods: cheaper relative to foreign goods, Consumers at home and
abroad buy more U.S. goods and fewer goods from other countries such as Higher exports, Lower imports and Higher net
exports
• An appreciation (rise) in the U.S. real exchange rate: U.S. goods - more expensive compared to foreign goods Consumers
at home and abroad – buy fewer U.S. goods and more goods from other countries, Lower exports, Higher imports and
Lower net exports
Purchasing-Power Parity
• Purchasing-power parity, PPP: Theory of exchange rates, A unit of any given currency should be able to buy the same
quantity of goods in all countries
• Basic logic of purchasing-power parity: Based on the law of one price, a good must sell for the same price in all locations
• Arbitrage: Take advantage of price differences for the same item in different markets, Result: the law of one price
• PPP: Parity: Equality, Purchasing-power: Value of money in terms of quantity of goods it can buy
• Implications of PPP
If purchasing power of the dollar is always the same at home and abroad then the real exchange rate cannot change. Theory
of purchasing-power parity “Nominal exchange rate between the currencies of two countries must reflect the price levels in
those countries”. Implications: Nominal exchange rates change whenprice levels change. When a central bank in any country
increases the money supply and causes the price level to rise. It also causes that country’s currency to depreciate relative to
other currencies in the world.
• Natural experiment, hyperinflation: High inflation, Arises when a government prints money to pay for large amounts of
government spending
• German hyperinflation, early 1920s: Money supply, price level, nominal exchange rate, Move closely together
• German hyperinflation, early 1920s: Money supply - starts growing quickly • Price level – starts growing; Depreciation.
Money supply – stabilizes • Price level and exchange rate – stabilize
• Quantity theory of money: Explains how the money supply affects price level
• Purchasing power parity: Explains how price level affects nominal exchange rate

Limitations of PPP
• Theory of purchasing-power parity does not always hold in practice: 1. Many goods are not easily traded 2. Even tradable
goods are not always perfect substitutes. When they are produced in different countries, there is noo opportunity for
profitable arbitrage
• Purchasing-power parity: Not a perfect theory of exchange-rate determination, Real exchange rates fluctuate over time
• Large and persistent movements in nominal exchange rates: Typically reflect changes in price levels at home and abroad
• Data on a basket of goods consisting of “Two all-beef patties, special sauce, lettuce, cheese, pickles, onions, on a sesame
seed bun” • “Big Mac” - sold by McDonald’s around the world
• January 2019: The price of a Big Mac was $5.58 in the United States
• According to purchasing power parity: –Cost of “Big Mac” – same in both countries –Predicted exchange rate = Price in
foreign country (in foreign currency) divided by price in U.S.
• Predicted and actual exchange rates: Are not exactly the same reasonable first approximation