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Purchasing power parity: Difference between revisions
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'''Purchasing power parity''' ('''PPP''') is an alternative measure of the wealth of nations based on the long-term equilibrium [[:en:exchange rate|exchange rate]] of two currencies to equalize their [[:en:purchasing power|purchasing power]]. Developed by [[:en:Gustav Cassel|Gustav Cassel]] in 1918,<ref>Gustav Cassel, "Abnormal Deviations in International Exchanges," in ''Economic Journal'', (December, 1918), 413-415</ref> it is based on the [[:en:law of one price|law of one price]]: the theory states that, in ideally efficient markets, identical goods should have only one price. | '''Purchasing power parity''' ('''PPP''') is an alternative measure of the wealth of nations based on the long-term equilibrium [[:en:exchange rate|exchange rate]] of two currencies to equalize their [[:en:purchasing power|purchasing power]]. Developed by [[:en:Gustav Cassel|Gustav Cassel]] in 1918,<ref>Gustav Cassel, "Abnormal Deviations in International Exchanges," in ''Economic Journal'', (December, 1918), 413-415</ref> it is based on the [[:en:law of one price|law of one price]]: the theory states that, in ideally efficient markets, identical goods should have only one price. | ||
This purchasing power SEM rate equalizes the purchasing power of different [[:en:Currency|currencies]] in their home countries for a given basket of goods. Using a PPP basis is arguably more useful when comparing differences in living standards on the whole between nations because PPP takes into account the relative ''cost of living'' and the ''inflation'' rates of different countries, rather than just a nominal [[gross domestic product | This purchasing power SEM rate equalizes the purchasing power of different [[:en:Currency|currencies]] in their home countries for a given basket of goods. Using a PPP basis is arguably more useful when comparing differences in living standards on the whole between nations because PPP takes into account the relative ''cost of living'' and the ''inflation'' rates of different countries, rather than just a nominal [[:en:gross domestic product|(GDP)]] comparison. The best-known and most-used purchasing power parity exchange rate is the [[:en:Geary-Khamis dollar|Geary-Khamis dollar]] (the "international dollar"). | ||
PPP exchange rate (the "[[:en:Exchange rate#Nominal and real exchange rates|real exchange rate]]") fluctuations are mostly due to market exchange rate movements. Aside from this volatility, consistent deviations of the market and PPP exchange rates are observed, for example (market exchange rate) prices of non-traded goods and services are [[Penn effect|usually lower]] where incomes are lower. (A [[:en:United States dollar|U.S. dollar]] exchanged and spent in [[India]] will buy more haircuts than a dollar spent in the [[:en:United States|United States]]). PPP takes into account this lower cost of living and adjusts for it as though all income was spent locally. In other words, PPP is the amount of a certain basket of basic goods which can be bought in the given country with the money it produces. | PPP exchange rate (the "[[:en:Exchange rate#Nominal and real exchange rates|real exchange rate]]") fluctuations are mostly due to market exchange rate movements. Aside from this volatility, consistent deviations of the market and PPP exchange rates are observed, for example (market exchange rate) prices of non-traded goods and services are [[Penn effect|usually lower]] where incomes are lower. (A [[:en:United States dollar|U.S. dollar]] exchanged and spent in [[India]] will buy more haircuts than a dollar spent in the [[:en:United States|United States]]). PPP takes into account this lower cost of living and adjusts for it as though all income was spent locally. In other words, PPP is the amount of a certain basket of basic goods which can be bought in the given country with the money it produces. | ||
