From this NY times article.
I was thinking about this over the weekend when my wife and I spied a house we liked in our neighborhood in Silver Spring just outside of DC. We aren’t ready to buy for a couple of years. When I compare the house from the weekend to similar houses in the neighborhood of Towson where I teach the houses are about 1/3 to ½ cheaper in Towson. The cost in Silver Spring might be about 4 to 5 times that of similar houses in Beloit, WI where I had my first job.
Difference in prices for non-tradable goods need to be corrected for in order to measure factors like GDP and income. It’s impossible to move a house (with the land) from DC to Beloit. But, we can move/ship a lot of things (cars, sweaters, beer, ect.) But remember when you buy that thing in DC like a sweater or beer, part of that costs pays for a shop to hold them in. For goods like sweaters you can buy online now, those costs are going to get closer or be the same. But for goods like houses and restaurant meals those good will have price differences in relation to differences in house prices.
So economists must estimate differences in prices and what people buy. This is tricky enough between Beloit and DC, but they also be able to compare Botswana and DC or at least Botswana and the US. To do this you compare similar goods and exchange rates, then see the differences.
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