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Purchasing Power Parity (PPP)

I have always been confused by this term. My teacher in International Economics in QAU would used derive it through some formulas which we will instantly memorize for the forthcoming Sessional Exams but really did not get what purchasing power parity means?? There were example in our book about the hair dress in US an in other part of world. The basic concept of PPP is that a currency normal exchange rate may not depict its original purchasing power. For example a hair dress in Pakistan costs say 85 Rs. It means it should be one dollar in USA. But it is not. There say it is in 5 dollars. So what the exchange rate is based on this? It is 16 PKR/USD. Thus in PPP the PKR value is much higher. So a basic concept of PPP is that the goods and services determine real exchange rate. An interesting PPP index is developed by the Economist which is called Big Mac Index, named after a famous product of an international fast food chain. It compares the prices of Big Mac in different countries of the world and tries to find the exchange rate. You see more on Big Mac on the web.

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