In order to compare the purchasing power of currencies of different countries, a statistical method is used which is purchasing power parity. Exchange rate and purchasing power parity should not be confused. To avoid this, we are going to enlighten you on the subject of purchasing power parities.
What is that ? Who uses them? What exactly are they for? We answer all these questions below.
What are purchasing power parities?
Purchasing power parities (PPP) are currency conversion rates which indicate differences in living standards between different countries. PPPs are used to equalize the purchasing power of various currencies, without taking into account differences in price levels.
In other words, purchasing power parities are price ratios of an identical good or service in national currency.
It exists two types of purchasing power parities:
- Absolute PPP,
- Relative PPP.
The absolute PPP is determined on a particular period, concerning two consumption baskets in two different countries. The absolute PPP is defined by comparing the price of these two identical baskets in the two countries.
Relative PPP defines the change in absolute purchasing power parities over two different periods.
How to calculate purchasing power parities?
The calculation of purchasing power parities is carried out two different ways, depending on the type of purchasing power parity.
Absolute PPP Calculation
The formula for calculating the absolute purchasing power parity between two countries is: PPPt = Pt/Pt
