Accurately determine the implied Purchasing Power Parity (PPP) exchange rate, check for consistency, or solve for a missing price using the latest economic principles.
PPP Calculator: Purchasing Power Parity Solver
Calculated Result:
Detailed Calculation Steps
Enter at least three values and click ‘Calculate’ to see the detailed steps.
PPP Calculator Formula
Sources: IMF | World Bank
Variables Explanation
- Price in Country A: The cost of a standardized basket of goods (or a single item, like the Big Mac Index) in the base country’s currency (e.g., USD).
- Price in Country B: The cost of the identical basket of goods in the comparison country’s currency (e.g., EUR).
- Actual Exchange Rate (A/B): The current, prevailing market exchange rate between Currency A and Currency B. This is used for comparison, not for the core PPP calculation.
- PPP Exchange Rate: The theoretical exchange rate that would equalize the price of goods between the two countries.
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What is PPP (Purchasing Power Parity)?
Purchasing Power Parity (PPP) is an economic theory that states that the exchange rate between two currencies should be equal to the ratio of the currencies’ respective purchasing powers. In simpler terms, it is the notion that a basket of goods should cost the same in two different countries when measured in a common currency. PPP is frequently used by economists as an alternative to market exchange rates to make more accurate comparisons of gross domestic product (GDP) and living standards between nations.
The principle of PPP is based on the law of one price, which suggests that in the absence of transaction costs and trade barriers, identical goods should sell for the same price in different markets. While the theory rarely holds perfectly due to factors like transportation costs, taxes, and non-tradable items, the PPP exchange rate serves as a key benchmark for determining whether a currency is undervalued or overvalued relative to another.
How to Calculate PPP Exchange Rate (Example)
Imagine the price of a standard laptop:
- Identify Prices: The laptop costs $1,500 in the US (Country A) and 2,000 CAD in Canada (Country B).
- Apply Formula: The PPP Exchange Rate is calculated as Price A / Price B.
- Calculation: $1,500 / 2,000 CAD = 0.75 USD/CAD.
- Interpretation: The PPP rate suggests that 1 CAD should be exchanged for 0.75 USD to equalize purchasing power. If the actual market rate is 0.80 USD/CAD, the Canadian dollar is considered theoretically undervalued by this measure.
Frequently Asked Questions (FAQ)
Is PPP a good predictor of short-term exchange rates?
No. While PPP is a fundamental theory for long-term exchange rate determination, it is generally considered a poor predictor of short-term currency movements due to factors like interest rates, capital flows, and market sentiment.
What is the difference between Absolute and Relative PPP?
Absolute PPP suggests that the price of the same basket of goods should be equalized across countries. Relative PPP focuses on the rate of change in prices; it suggests that the change in the exchange rate between two countries over time should equal the difference in their inflation rates.
Why do economists use PPP-adjusted GDP?
Economists use PPP-adjusted GDP to compare the economic output and living standards of countries more accurately. Market exchange rates can fluctuate wildly, but PPP adjusts for local price differences, giving a truer picture of the real volume of goods and services produced.
What is the ‘Big Mac Index’?
The Big Mac Index, published by The Economist, is a lighthearted but effective measure of PPP. It compares the price of a Big Mac hamburger in different countries to determine whether currencies are at their ‘correct’ level.