Alternative measures of output in global economic–environmental models: Purchasing power parity or market exchange rates? — Comment

Abstract

Nordhaus [Nordhaus, W. 2006, Alternative measures of output in global economic–environmental models: purchasing power parity or market exchange rates? Energy Economics, doi 10.1016/j.eneco.2006.02.003] examines the question of the use of purchasing power parity versus market exchange rates in constructing global economic models. He concludes that the best approach is to use PPP measures for relative incomes and outputs and national accounts' prices and quantity indexes for time series extrapolations. In this comment we argue and show that international real income comparisons based on PPP measures overstate the real incomes of poorer countries and underestimate the real incomes of richer regions. This is the case because the PPP approach fails to account for the differences in various non-traded attributes, such as availability of public goods and the location, attached to the final sale of the goods being compared. Additionally, using a teleporting consumer model we show that the use of real exchange rates to convert real quantities and the use of market exchange rates to convert nominal incomes preserve real income rankings across nations and this approach is consistent with standard economic theory.