Power purchasing parity (PPP) is an economic theory that estimates the amount of adjustment needed on the exchange rate between countries in order for the exchange to be equivalent to each currency’s purchasing power. In other words, the exchange rate adjusts so that an identical good in two different countries has the same price when expressed in the same currency.
This theory involves a basket of goods that are traded between markets should cost the same in different markets. For example, the “Big Mac Index”,which is calculated and published annually by The Economist. If a Big Mac costs $4 in the US and 3 dollars in the Canada, then the proper exchange rate between the two currencies should be four dollars to three pounds which works out to be 1.33 dollars US per dollars Canada.
Advantages of Power purchasing parity
A main advantage is that Power purchasing parity exchange rates tend to be relatively stable over time. Market rates are usually unpredictable, and their application could produce reasonably large swings in collective measures of development even when progression rates in different countries are stable. Since wages are usually lower in poorer countries and most firms tend to belabor intensive, the price of their products tendsto be cheaper. Any business analysis that does not take such issues into account, the variance in the cost of non-traded products willincline to underestimating the customer’s purchasing power in the emerging market as well as in developing countries consequently. In line with this, PPP is usuallyviewed as a healthier way of measuring overall well-being.
Disadvantages of Power purchasing parity:
The main one is that measuring Power purchasing parity can be challenging. The ICP is a significant statistical task, and new price assessments are obtainable only at uncommon intervals. The Power purchasing parity rates must be estimated between survey dates, which can result in inaccuracies in measurement.