Purchasing power parity
Purchasing power parity (PPP) is a term that measures prices in different areas using a specific good or goods to contrast the absolute purchasing power between different currencies. In many cases, PPP produces an inflation rate that is equal to the price of the basket of goods at one location divided by the price of the basket of goods at a different location. The PPP inflation and exchange rate may differ from the
Purchasing power parity is an
Poverty, tariffs, and other frictions prevent trading and purchasing of various goods, so measuring a single good can cause a large error. PPP term accounts for this by using a "basket of goods", that is, many goods with different quantities. PPP then computes an inflation and exchange rate as the ratio of the price of the basket in one location to the price of the basket in the other location. For example, if a basket consisting of 1 computer, 1 ton of rice, and 1 ton of steel was 1800 US Dollars in New York and the same goods cost 10800 HK Dollars in Hong Kong, the PPP exchange rate would be 6 HK Dollars for every 1 US Dollar.
The name "purchasing power parity" comes from the idea that, with the right exchange rate, consumers in every location will have the same
The value of the PPP exchange rate is very dependent on the basket of goods chosen. In general, goods are chosen that might closely obey the Law of One Price. So, ones traded easily and are commonly available in both locations. Different organizations that compute PPP exchange rates use different baskets of goods and can come up with different values.
The PPP exchange rate may not match the market exchange rate. The market rate is more
Because PPP exchange rates are more stable and are less affected by tariffs, they are used for many international comparisons, such as comparing countries' GDPs or other national income statistics. These numbers often come with the label "PPP-adjusted".
There can be marked differences between purchasing power adjusted incomes and those converted via market exchange rates. A well-known purchasing power adjustment is the
There are variations to calculating PPP. The EKS method (developed by Ö. Éltető, P. Köves and B. Szulc) uses the