Summary
Purchasing Power Parity (PPP) is an economic concept that compares the buying power of different currencies by adjusting for the differences in price levels across countries. The idea is that, in the long run, exchange rates should equalize the price of identical goods and services in any two countries.
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Content
How Does PPP Work?
- It’s based on the principle that “a basket of goods and services” should cost the same in different countries when priced in a common currency.
- PPP adjusts GDP figures to reflect how much people in different countries can actually afford with their income.
Example of PPP
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The Cost of a Hamburger:
- In the US, a hamburger might cost $5.
- In India, the same hamburger might cost ₹150, which is approximately $1.80 at the market exchange rate.
- PPP Exchange Rate: For this specific item, $1 = ₹30 (instead of the actual exchange rate, which might be closer to ₹83).
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What PPP Reveals:
- In nominal terms (using market exchange rates), it seems like Indian incomes are lower.
- But when adjusted for PPP, Indians can buy more with ₹150 than Americans can with $1.80 in their local economies.
An example of the technique used to estimate the PPP is the Big Mac Index