Enter the cost of a standard item (basket of goods) in the base currency (e.g., US Dollar).
Enter the cost of the exact same item in the target currency (e.g., Euro).
How much of Currency B can you buy with 1 unit of Currency A?
Implied PPP Exchange Rate:–
Actual Market Rate:–
Valuation Difference:–
Conclusion:–
How to Calculate PPP Exchange Rate
Purchasing Power Parity (PPP) is an economic theory used to determine the relative value of currencies. The concept estimates the amount of adjustment needed on the exchange rate between countries in order for the exchange to be equivalent to (or at par with) each currency's purchasing power.
The most famous example of this is the "Big Mac Index," popularized by The Economist. It compares the price of a McDonald's Big Mac in two different countries to determine if a currency is undervalued or overvalued relative to the US Dollar.
The PPP Formula
The calculation for the implied PPP exchange rate is straightforward. It is based on the "Law of One Price," which states that in the absence of transportation costs and trade barriers, identical goods should have the same price in different markets when expressed in the same currency.
Formula:
S = PB / PA
S: The Implied PPP Exchange Rate.
PB: The price of the good in Quote Currency (Currency B).
PA: The price of the good in Base Currency (Currency A).
Example Calculation
Let's assume we are comparing the US Dollar (Base) and the British Pound (Quote).
Price of a widget in USA: $10.00
Price of the same widget in UK: £6.00
Actual Market Exchange Rate: 1 USD = 0.75 GBP
Step 1: Calculate Implied PPP Rate
Implied Rate = £6.00 / $10.00 = 0.60 This means 1 USD should equal 0.60 GBP based on purchasing power.
Step 2: Compare to Market Rate
The market says 1 USD buys 0.75 GBP. Since the market gives you more Pounds than the price of goods implies (0.75 > 0.60), the Dollar is effectively overvalued relative to the Pound (or the Pound is undervalued).
Interpreting the Results
Our calculator provides the percentage valuation difference using the following logic:
Implied Rate > Market Rate: The Base Currency (A) is Undervalued. It buys less Currency B on the market than it should based on prices.
Implied Rate < Market Rate: The Base Currency (A) is Overvalued. It buys more Currency B on the market than it should based on prices.
Implied Rate = Market Rate: The currencies are trading at Parity.
Limitations of PPP
While PPP is a powerful tool for long-term economic analysis, it does not always hold true in the short term due to several factors:
Transport Costs: Moving goods between countries adds cost not reflected in the item price.
Taxes and Tariffs: Import duties can artificially inflate prices in one region.
Non-Tradable Services: The price of a burger includes rent, labor, and utilities, which cannot be traded across borders.
Market Sentiment: Speculation often drives exchange rates away from economic fundamentals.
function calculatePPP() {
// 1. Get input values
var priceA = document.getElementById("priceDomestic").value;
var priceB = document.getElementById("priceForeign").value;
var marketRate = document.getElementById("marketExchangeRate").value;
// 2. Parse values to floats
var pA = parseFloat(priceA);
var pB = parseFloat(priceB);
var mRate = parseFloat(marketRate);
// 3. Validation
if (isNaN(pA) || isNaN(pB) || isNaN(mRate) || pA <= 0 || pB <= 0 || mRate Implied Rate (0.80), Currency A buys more B than it 'should'. Currency A is Overvalued.
// Percent Difference = (Market Rate – Implied Rate) / Implied Rate * 100
var valuationDiff = ((mRate – impliedRate) / impliedRate) * 100;
// 6. Determine Conclusion Text and Class
var conclusionHtml = "";
var baseCurrencyText = "Base Currency (A)";
if (Math.abs(valuationDiff) < 1) {
conclusionHtml = "Fairly Valued";
} else if (valuationDiff > 0) {
// Market Rate > Implied Rate. Base Currency is getting more than expected. Overvalued.
conclusionHtml = "Overvalued by " + Math.abs(valuationDiff).toFixed(2) + "%";
} else {
// Market Rate < Implied Rate. Base Currency is getting less than expected. Undervalued.
conclusionHtml = "Undervalued by " + Math.abs(valuationDiff).toFixed(2) + "%";
}
// 7. Display Results
document.getElementById("impliedRateDisplay").innerText = impliedRate.toFixed(4);
document.getElementById("marketRateDisplay").innerText = mRate.toFixed(4);
document.getElementById("differenceDisplay").innerText = (valuationDiff > 0 ? "+" : "") + valuationDiff.toFixed(2) + "%";
document.getElementById("conclusionDisplay").innerHTML = baseCurrencyText + " is " + conclusionHtml;
// 8. Show result container
document.getElementById("result-container").style.display = "block";
}