What does purchase power parity mean?

Answer 1

Let us consider the following: If you can buy 10 units of a commodity in country X for $1 and if you can buy 5 units of the same commodity in country Y for $1, then the purchase power parity (ppp) of country X is twice that of country Y. This is roughly equivalent to exchange rates of currencies of countries X and Y. Usually ppp is given as annual per capita income (PCI) of a country multiplied by the yearly average exchange rate of that country's currency against USD. For example if a country's PCI is 1000 USD and the exchange rate is 5, then the ppp will be 5000 USD.

Answer 2

Purchjasing power parity (PPP) has several different meanings depending on the context. The simplest version of PPP theory says that, for goods where transport costs are small, the price should be the same when translated into a common currency. This is the basis for the Big Mac index published in the Economist magazine. In other words, a Big Mac is virtually identical no matter where you buy it in the world and so, according to the theory, should be the same price everywhere. If it is not, then it suggests that the exchange rate for the two countries being compared may not be in equilibrium. Unfortunately, when economists do big studies and apply fancy mathematics (known as econometrics) to test whether PPP holds in the real world over time, the results are, at best, mixed. A number of reationales have been proposed for why this is the vase. Therefore, this concept of PPP is a really useful theoretical construct, but often not that useful in a real world situation. However, it is important to note that this doesn't mean that PPPs have no use.

One area where PPP is vital is when comparing living standards across countries. Each country calculates its GDP in its own currency. This is okay for comparing how its GDP has increased over time. It is then tempting to compare GDP across countries just my multiplying by whatever the exchange rate is to compare GDPs. However, since PPP doesn't hold for individual prices, this can be misleading. For example, suppose US GDP is $2 per person adn in Japan is 1000Y/person and that the exchange rate is $1=400Y. Using these figures, you would get convert Japanese GDP to $2.50/person and conclude that Japan has a higher living standard. However, suppose that the cost of living (measured in apples, say) means that apples cost $1 in the US, but 800Y in Japan and that apples are the main product that people buy in both countries. If you convert using apples, the average person in the US can afford 2, while the average person in Japan can only afford 1.25, meaning that the American is better off in real terms. This is why economists calculate international GDP comparisons using PPP terms using a broad average of all of things people buy in each country so that they can compare how much better off people are in different countries.

To summarise, while PPP theory makes sense, PPP is not a very good way of predicting whether an exchange rate is out of equilibrium and will move up or down, but when comparing GDP across countriesto make conclusions about living standards, you must use PPP based measures of GDP.

Answer 3

Purchasing Power Party tells you how much one currency is worth in relation to another country's currency

An example:
lets assume that one USD is equal to 2 canadian dollars. I want to buy a book in the US that costs 20 USD, but in Canada that same Book only costs 15 Canadian Dollars. That would mean that in Canada the book would cost only 7.5 USD.

Since Canada's dollar can buy that book for roughly 1/3 the Canadian dollars' PPP is higher than the US's