Economics has many articles of faith. One of the most dearly held is Purchasing Power Parity, which posits that the price of the same good in different regions should be equivalent when no barriers to arbitrage exist. Because Purchasing Power Parity (PPP) is an important assumption in much of international economic theory, this article examines empirical evidence testing this proposition.
Instead of analyzing international data, this study analyzes PPP between regions of the United States. By comparing regions within a country, it eliminates many of the hypotheses offered to explain the failure of PPP. The results of this study are suggestive. PPP fails to hold within regions of the United States. Instead, the inclusion of nontraded goods in the total consumer price indices for these regions is shown to be the major cause of this failure. When the nontraded components of these indices are removed, PPP holds. Some categories of goods do seem to move in lockstep while others do not, as one would expect, and as PPP predicts.