PURCHASING POWER PARITY - 10 Mints Seminar Notes

PURCHASING POWER PARITY - 10 Mints Seminar Notes

MEANING:

• Purchasing power parity (ppp) is a popular metric used by macroeconomic analysts that compares different countries currencies through a “basket of goods “ approach

• Purchasing power parity (ppp) allows for economics to compare economic productivity and standards of living between countries

 

CALCULATION:

We can calculate purchasing power parity by the price of basket of good in that country by the price of basket of goods in another country
     Formula = p1/p2
       
By calculating this we get purchasing power parity exchange rate.

VARIATIONS:

• There are variations to calculating PPP. The EKS method uses the geometric mean of the exchange rates computed for individual goods.The EKS-S method uses two different baskets, one for each country, and then averages the result. 

• While these methods work for 2 countries, the exchange rates may be inconsistent if applied to 3 countries, so further adjustment may be necessary so that the rate from currency A to B times the rate from B to C equals the rate from A to C.

ISSUES:

• The PPP exchange-rate calculation is controversial because of the difficulties of finding comparable baskets of goods to compare purchasing power across countries.

• Estimation of purchasing power parity is complicated by the fact that countries do not simply differ in a uniform price level; rather, the difference in food prices may be greater than the difference in housing prices, while also less than the difference in entertainment prices.

• People in different countries typically consume different baskets of goods. It is necessary to compare the cost of baskets of goods and services using a price index. This is a difficult task because purchasing patterns and even the goods available to purchase differ across countries.

• Thus, it is necessary to make adjustments for differences in the quality of goods and services. Furthermore, the basket of goods representative of one economy will vary from that of another: Americans eat more bread; Chinese more rice. Hence a PPP calculated using the US consumption as a base will differ from that calculated using China as a base. Additional statistical difficulties arise with multilateral comparisons when(as is usually the case) more than two countries are to be compared.

Presented by

Safiya Begum I

Banking Student

Magme School of Banking