What is Purchasing Power Parity Calculator ?
Purchasing Power Calculator, Purchasing power parity or PPP is a theory used to adjust currency exchange rates such that they can be compared against each other to determine their purchasing power. Simply put, if you buy a similar commodity using either of the currencies, the expense incurred should be the same in both currencies if the exchange rate is considered.
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You require a salary of _______ in ‘s local currency to live a similar quality of life as you would with a salary of _______ in ‘s local currency.
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Purchasing Power Calculator Why We Use It ?
Purchasing power parity is used across the globe to estimate and compare income levels across countries. It helps us understand and interpret the currencies and cost structures of each country.
For instance, let’s say that a dress from Zara costs Rs. 5,000 in India. We would expect the dress to cost around $60 in the USA considering the ongoing exchange rate of 80 between the US dollar and the rupee.
PPP Thoery Really Reliable ?
PPP does not necessarily give a clear picture of the standard of living of countries. Here’s why:
- PPP involves many assumptions regarding consumption patterns and associated price levels.
- Constructing baskets of identical goods and services may be a challenge, especially if comparing dissimilar countries. This is because people may have different preferences and the quality of the offerings may differ accordingly.
- Traded goods do not necessarily trade at equal price levels since there may be cross-border restrictions. This may result in a deviation from PPP.
PPP Calculator or Purchasing Power Calculator Uses
- Economists use the concept of PPP to compare and draw parallels between the economic outputs of different countries.
- It is also used in combination with GDP measures to determine the economic health of countries.
- PPP helps traders and investors who deal in foreign currency. It can be used to estimate the strength or weakness of a currency.
- In some cases, it can also be used to determine exchange rates for new economies and forecast future exchange rates.
How purchasing power is calculated ?
The basic-heading PPP for each pair of economies can be computed directly by taking the geometric mean of the price relatives between them for the two kinds of rice. This is a bilateral comparison. The PPP between economies B and A can be computed indirectly: PPP C/A × PPP B/C = PPP B/A.
The calculation is undertaken in three stages. The first stage is at the product level, where price relatives are calculated for individual goods and services.
A simple example would be a litre of Coca-Cola. If it costs 2.3 euros in France and 2.00$ in the United States then the PPP for Coca-Cola between France and the USA is 2.3/2.00, or 1.15.
This means that for every dollar spent on a litre of Coca-Cola in the USA, 1.15 euros would have to be spent in France to obtain the same quantity and quality - or, in other words, the same volume - of Coca-Cola.
The second stage is at the product group level, where the price relatives calculated for the products in the group are averaged to obtain unweighted PPPs for the group. Coca-cola is for example included in the product group “Softdrinks and Concentrates”.
The third stage is at the aggregation levels, where the PPPs for the product groups covered by the aggregation level are weighted and averaged to obtain weighted PPPs for the aggregation level up to GDP (in our example, aggregated levels are Non-alcoholic beverages, Food…).