PPP is an economic technique used to determine the relative value of two currencies

1. Purchasing Power Parity
(PPP)
AMIT PAGADA
M.Pharm. (Clinical Research)

2. Defination
PPP is an economic technique used to determine the
relative value of two currencies
PPP is the rate of currency conversion that equalize the
purchasing power of different currencies by eliminating
the differences in price levels between countries
Developed by Gustav Cassel in 1918, the theory states
that, in ideally efficient markets, identical goods should
have only one price

3. Need of PPP
Suppose that 1 USD = 50 INR
In the United States, wooden cricket bats sell for $40
while in India, they sell for 750 Rupees
Since 1 USD = 50 INR, the bat which costs $40 USD in
U.S costs only 15 USD if we buy it in India
Clearly there’s an advantage of buying the bat in India,
so consumers would be happier to buy the bat in India

4. Continues….
If consumers decide to do this, we should expect to see
three things happen:
American consumers’ demand for Indian Rupees would
increase which will cause the Indian Rupee to become
more expensive
The demand for cricket bats sold in the United States
would decrease and hence its prices would tend to
decrease
The increase in demand for cricket bats in India would
make them more expensive

5. Continues….
In an ideal scenario, prices in both countries would
become equal at some price point.
The increased demand for INR, for instance may lead an
increase in its value such that 1 USD = 40 INR.
Secondly, due to decrease in demand for the bats in the
US, its price drops to USD 30. Thirdly, the increase in
demand for the bats in India takes its price up to INR
1200

6. Continues….
Purchasing-power parity theory tells us that price
differentials between countries are not sustainable in the
long run as market forces will equalize prices between
countries and change exchange rates in doing so
In the long run, having different prices in the United
States and India is not sustainable because an individual
or company will be able to gain an arbitrage profit by
buying the good cheaply in one market and selling it for
a higher price in the other market.

7. PPP Calculation
Absolute PPP
The Absolute Purchasing Power Parity relation is:
P/ PF = E
P is the domestic price index,
PF is the foreign price index,
E is the spot exchange rate (domestic currency units per
unit of the foreign currency)

8. Example
A simple example would be a litre of Coca-Cola
If it costs 2.3 euros in France and 2.00$ in the United
States
The PPP for Coca-Cola between France and the USA is
2.3/2.00, or 1.15
This means that for every dollar spent on a litre of Coca-
Cola in the USA, 1.15 euros would have to be spent in
France to obtain the same quantity and quality - or, in
other words, the same volume - of Coca-Cola

9. Usefulness of PPP
The major use of PPP is as a first step in making inter-country
comparisons in real terms of gross domestic product (GDP)
and its component expenditures.
GDP is the aggregate used most frequently to represent the
economic size of countries and, on a per capita basis, the
economic well-being of their residents
Calculating PPP is the first step in the process of converting
the level of GDP and its major aggregates, expressed in
national currencies, into a common currency to enable these
comparisons to be made

10. GNI per capita, PPP$
GNI per capita based on purchasing power parity (PPP)
PPP GNI is gross national income (GNI) converted to
international dollars using purchasing power parity rates.
GNI is the sum of value added by all resident producers
plus any product taxes (less subsidies) not included in
the valuation of output plus net receipts of primary
income (compensation of employees and property
income) from abroad
GNI per capita, PPP (current international $) _ Data _
Table.pdf

11. PPP conversion factor to market
exchange ratio
Purchasing power parity conversion factor is the number
of units of a country's currency required to buy the same
amount of goods and services in the domestic market as
a U.S. dollar would buy in the United States
The ratio of PPP conversion factor to market exchange
rate is the result obtained by dividing the PPP
conversion factor by the market exchange rate
PPP conversion factor (GDP) to market exchange rate
ratio _ Data _ Table.pdf

12. Continues....
The ratio, also referred to as the national price level,
makes it possible to compare the cost of the bundle of
goods that make up gross domestic product (GDP)
across countries
It tells how many dollars are needed to buy a dollar's
worth of goods in the country as compared to the United
States

13. Thank You