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PhiNotPi's avatar

Does outsourcing create purchasing power? If not, then what is the long term effect?

Asked by PhiNotPi (12681points) April 26th, 2012

When comparing currency in different parts of the world, there are two different things to consider: the exchange rate between the currencies, and the purchasing power of the currencies.

The purchasing power of a person is the amount of goods/services a person can buy with all of his money.
Purchasing power of a currency describes how much a certain amount of money can buy.
If a group is paid half as much, but the cost of living is half as much, then the purchasing power of the people stays the same. The purchasing power of their currency is twice as much becuase a single unit can buy twice as many goods/services.

So, here’s the scenario:

Persons 1 & 2 have a salary of $100,000 and a cost of living of $90,000 (just to use some nice round numbers). Person 3 has a salary of $90,000 and a cost of living of $81,000. Comparing the cost of living to the salary, all three people have the same purchasing power. However, a $1 bill can buy more where person 3 lives compared to where the other two people live.

Let’s say that historically person 1 has been buying $100 of goods from person 2. Just recently, a better means of transportation allows person 1 to buy $100 of goods from person 3 for the price of only $90. Compared to person 3’s cost of living, this seems like an appropriate amount of money, since $90 is the equivalent of $100 to him in terms of how much it can buy.

Here’s the question: Since person 3 received a fair trade ($90 for what would be worth $90 in his area) but person 1 made some profit ($90 for what would be worth $100 in his area), where does this extra money come from? Obviously, no physical dollar bills were made, but in terms of the total value of all of the goods and currency, it seems like more value has been created.

Another question is: Assuming that the extra purchasing power was actually created from nothingness, how will it be destroyed? Is this the creation of a bubble, which will then pop and destroy the extra value?

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