In my previous post, using the nominal exchange rate we could compare the prices of iPods across countries. That was the simple version, and since it doesn’t take inflation into account, it won’t be as accurate. By calculating the Real Exchange Rate, we can get a more accurate answer to the question; which country has the cheapest iPod?
Since an iPod nano (8GB), is the same product in all countries, shouldn’t it be priced closely?
The assumption here is that there are no transportation costs (very hypothetical) and trade flows freely across all borders (i.e., no tariffs). It is fair also to assume has a significant market share and monopoly power all over the world in mp3 players, so demand shouldn’t affect price as much.
Note: All prices indicated are exclusive of taxes. Also, China produces all iPods but it is an American product, so we shall take America as the home country.
We will need to calculate the Real Exchange Rate (RER), which gives us the value of a good in terms of the same good in another country. Our home country in this example will be USA. If the RER is equal to one, then we have purchasing power parity (ex: the exchange rate reflects that the two iPods in the UK and the USA are the same, so Pounds and USD should allow us to buy goods for the same price).
Real Exchange Rate = (Nominal Exchange Rate) x (Price abroad/Price at home)
The iPod Index
- Hong Kong
- South Africa
- South Korea
- United Kingdom
If any of the Real Exchange Rates were less than 1.0, then someone could buy an iPod in their country and sell them in the US. One of the drawbacks is that the exchange rate that was used is a current exchange rate, taking a yearly average would be more accurate.
Note: Buying iPods in the US and selling them in Argentina is very profitable.