Purchasing power parity is a concept that measures the amount of purchasing power that two countries have about one another. It is essential because it allows us to compare the prices of goods and services in different countries.
PPP is an essential concept in economics because it helps explain why some countries have lower prices than others.
The term “purchasing power parity” was coined by William Stanley Jevons in 1865. The idea was initially developed to explain the relationship between prices and incomes, but Jevons’s theory has since been extended to other areas such as international trade and capital flows.
In its most basic form, purchasing power parity is a method for comparing countries’ exchange rates so that one country’s currency can be exchanged for another country’s money with no change in the price or value of goods or services.
Purchasing power parity (PPP) is a way of comparing the price of identical goods in different countries and is unhelpful or comparing living standards. As countries use foreign currencies, the theory provides a way to calculate the appropriate exchange rate for incomes and prices in different countries. PPP assumes that products should cost the same in all countries.
Let’s understand the concept of PPP with the help of an example:
Example: Purchasing Power of Parity
Suppose a basket of goods costs $100 in the USA and the same basket costs Rs 7,500 in India. In that case, the PPP theory predicts that the exchange rate between the two countries would be $1=Rs 75. If two economies experience differing inflation rates, then, over time, the exchange rate will tend to alter in restoring purchasing power parities.
If, after several years, the basket of goods now costs $150 in the USA due to the impact of inflation on USA prices whereas it only rises to Rs 10,000 in India, this would suggest that the exchange rate between the two currencies should now be $1= Rs 66.67. This means that there is a decline in the value of US dollars.
Since 1986, The Economist has published its famed ‘Big Mac Index’ – an informal way of measuring the PPP between two currencies. Its purpose is to make complex exchange rate theory as digestible as a Big Mac.
Why is Purchasing Power Parity Important for Businesses & Consumers?
It is important to remember that purchasing power parity (PPP) is a measurement of the price of a country’s currency against another country’s currency. The PPP is important for many reasons, one being that it allows us to compare countries and countries with different prices.
It helps us understand which countries have comparable prices to compare them. A country such as Switzerland and Norway have very similar PPPs, but they are both costly compared to countries like India and China. The PPP also provides insight into how much money people in different countries earn daily.
Conclusion: Importance of PPP in Understanding World Economy
The purchasing power parity (PPP) concept has been around for a while. It is the idea that when two countries’ currencies are equal in value, they should also be equivalent in purchasing power or exchange rate. This means that buying one dollar in one country should be the same as buying the same one in another. The PPP also helps to compare countries on their economic strength and competitiveness.
In our current world, where we have many different currencies, it is essential to understand how to compare them and determine which currency will give you better results than another.
This content will discuss two ways of doing this: 1) Using PPPs for comparison between countries, and 2) Using PPPs for comparing the world’s economies.
