Economic Development Indices Questions Medium
Purchasing Power Parity (PPP) is calculated by comparing the prices of a basket of goods and services between different countries. The basic idea behind PPP is to determine the exchange rate that would make the purchasing power of a currency equal in different countries.
To calculate PPP, economists collect data on the prices of a representative basket of goods and services in each country. This basket typically includes items such as food, housing, transportation, and other essential goods and services. The prices of these items are then converted into a common currency, usually the US dollar, using the prevailing exchange rates.
Once the prices are converted into a common currency, economists compare the cost of the basket of goods and services in different countries. If the cost of the basket is higher in one country compared to another, it suggests that the currency of the first country is overvalued, while the currency of the second country is undervalued.
To calculate the PPP exchange rate, economists adjust the exchange rate between two currencies based on the relative cost of the basket of goods and services. If the cost of the basket is higher in one country, the exchange rate is adjusted downwards to reflect the lower purchasing power of that currency. Conversely, if the cost of the basket is lower in one country, the exchange rate is adjusted upwards to reflect the higher purchasing power of that currency.
The PPP exchange rate provides a more accurate measure of the relative purchasing power of different currencies, as it takes into account the differences in prices between countries. It is widely used in international comparisons of living standards, economic development, and poverty levels.