What is it used for ? - Deepstash

# What is it used for ?

PPP as a theoretical exchange rate allows you to buy the same amount of goods and services in every country.

Eg: If you want to live inexpensively and you can move to any country in the world, compare the prices of McDonald's Big Mac.

Government agencies use it to compare the output of countries that use different exchange rates.

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MORE IDEAS FROM What Is Purchasing Power Parity (PPP)?

The World Bank releases a report that compares the productivity and growth of various countries in terms of PPP and U.S. dollars.

The International Monetary Fund and the Organization for Economic Cooperation and Development use weights based on PPP metrics to make predictions and recommend economic policy. These policies can have an immediate short-term impact on financial markets.

Also, Investors who hold stock or bonds of foreign companies may use the survey's PPP figures to predict the impact of exchange-rate fluctuations on a country's economy, and thus the impact on their investment.

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PPP is an economic theory that compares different countries' currencies through a "basket of goods" approach.

According to this concept, two currencies are in equilibrium or considered being at par—when a basket of goods is priced the same in both countries, taking into account the exchange rates.

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Accounting GDP for PPP value.

This adjustment attempts to convert nominal GDP into a number more easily comparable between countries with different currencies.

To better understand, suppose it costs \$10 to buy a shirt in the U.S., and it costs €8.00 to buy an identical shirt in Germany. To make an apples-to-apples comparison, we must first convert the €8.00 into U.S. dollars. If the exchange rate was such that the shirt in Germany costs \$15.00, the PPP would therefore be 15/10, or 1.5.

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The relative version of PPP is calculated as

S=P1/P2

S= Exchange rate of currency 1 to currency 2

P1 = Cost of good X in currency 1

P2 = Cost of good X in currency 2

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Some factors explain why PPP is not a good reflection of reality.

• Tax differences: Government sales taxes such as the value-added tax (VAT) can spike prices in one country, relative to another
• Government Intervention: Tariffs can dramatically augment the price of imported goods, where the same products in other countries will be comparatively cheaper.
• Market Competition: Goods might be deliberately priced higher in a country. Higher prices are because a company may have a competitive advantage over other sellers. The company may have a monopoly keeping them artificially high.

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A meaningful comparison of prices across countries requires a wide range of goods and services. To facilitate this University of Pennsylvania and UN joined forces to establish International Comparison Program.

PPPs generated by the ICP have a basis from a worldwide price survey that compares the prices of hundreds of various goods and services. The program helps international macroeconomists estimate global productivity and growth.

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RELATED IDEA

• This is the most basic indicator of the overall market value of a nation's finished domestic goods and services and the country's health and size.
• There are two types of GDP: real and nominal. The former is the economic output after inflation is factored in while the latter does not take inflation into account.
• The GDP is important because it gives us an idea of whether the economy of the country is growing or contracting.

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• Fast food consumption can be used as an index to measure consumer behaviour and market changes.
• The Pizza Principle, first noticed in New York City in the 80s, revealed that the cost of a subway ride and a slice of pizza remained the same for two decades.
• How much a Big Mac from Mcdonalds (or a similar offering from KFC) costs around the world can measure how the same product costs in different countries. If the product price is the same, the countries have a Purchasing Power Parity (PPP).

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• Inflation is a situation of rising prices in the economy.
• Inflation is a sustained increase in the general price level in an economy. Inflation means an increase in the cost of living as the price of goods and services rise.
• The rate of inflation measures the annual percentage change in the general price level.

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