Purchasing Power Parity (PPP)
IntermediateAlso known as: PPP Purchasing power parity (PPP) is an economic theory and measurement method that compares currencies by the amount of goods and services they can buy, so that the same basket of goods should cost the same in different countries once prices are converted into a common currency. PPP has two main uses. First, it is used as a theory of exchange rates: over the long term, exchange rates should move towards the level at which identical goods cost the same everywhere. Second, it is used to compare living standards and economic output across countries more fairly. A well-known informal illustration is comparing the price of a hamburger in different countries. Suppose a burger costs 5 dollars in the United States and 600 yen in Japan. The implied PPP exchange rate is 120 yen per dollar. If the actual exchange rate is 150 yen per dollar, the yen buys more in Japan than its market rate suggests, implying it is undervalued by about 20%. PPP-adjusted figures are widely used for international comparisons of GDP and incomes. Market exchange rates can understate living standards in countries where many local goods and services are cheap. In practice, exchange rates can differ from PPP for long periods, because of trade barriers, transport costs, taxes and goods and services that cannot easily be traded.
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