EXPLAINING PRICE COMPARISONS
HELLO country. I have posted on my page price comparisons made by “the candidates” Facebook page. I am however very worried about the financial literacy of some of my followers because they are simply misusing terms thrown at them by their “media team”
Let me educate us a bit. In looking at which country has the cheapest goods, please don’t even mention GDP, GDP per capita, minimum wage or any other metric. Something is cheap if you can pay for it less in one market as compared to another market.
For your better understanding, you need to know the concept of “International parity relationships. Market Parity means that prices of the same product are equal in two different markets.
For example, if the price of mealie meal in Zambia is K140 and in South Africa it’s also K140 as converted using official exchange rates, then we have a price parity for mealie meal prices between Zambia and South Africa.
This means it will be pointless for a trader to import mealie meal from South Africa into Zambia and vice versa because they won’t be able to make any profits. Prices are equal i.e. they are at parity.
Now if mealie meal in Zambia is K140 and in South Af
rica it is K380, then you have what is know as a “Market Arbitrage” condition. It means a trader can make a profit by buying mealie meal in Zambia cheaply and selling it in South Africa at a higher price.
The profit will be calculated as K380 minus K140 including any other associated costs. It’s however common sense that to make profits in this example one will have to export in bulk!
The other concept people are misusing is what is known as the PPP. The PPP not to be confused with Public Private Partnership is called the Purchasing Power Parity theory. The PPP theory comes from the “Law of one Price” discovered by the School of Salamanca centuries ago.
The PPP theory states that the real exchange rates between currencies should be derived from prices of identical goods and not based on supply and demand of forex.
It states that the real exchange rate for example between the Kwacha and the SA rand S(ZMW/ZAR) = the price of 25kg of mealie meal in Zambia divided by the price of 25kg bag of mealie meal in South Africa.
So in our example based on PPP, S(ZMW/ZAR) = is 140/380 = I rand = K0.3584 and not the current exchange rate fixed by the central banks of 1 rand is K1.58.
Kindly note that the PPP takes off transportation costs and differential taxes. It also assumes that markets are perfect. The most common index used to compare the real exchange rate is called the Big Mac index
So in simple terms, a product is cheaper in Zambia if it is more expensive to get outside the country or vice versa. The issue of affordability depends on an individual’s pocket and preferences.
The way people perceive different products and their importance. For example, for some urban dwellers in Zambia, mealie meal at K135 per 25kg bag is expensive while two six-packs of Castle Lite at K136 is cheap.
For a person living in rural Zambia, salt is more important than beef that is why they will sell goats cheaply but buy salt expensive. In fact, the concept of cost of living is more pronounced in urban areas than in rural areas because people in rural areas live on the land. Even for city dwellers that have small holdings or farms, issues to do with mealie meal, vegetables and other things are not cardinal.
My advice is that let’s grow to export given the overwhelming arbitrage conditions in our favour!
For more reading, google:
- Law of one price - Interest rate arbitrage - the Big Mac index etc