What is purchasing power parity?

Purchasing power parity

The PPP or purchasing power parity is a macro-economic metric that can be used to measure a country’s GDP. The PPP uses a basket of goods approach ie: a set of goods which is bought by these currencies.

The currencies are first converted into dollar value. Then, the amount of dollar value which can buy the same basket of goods in two countries can be calculated.

Eg:

Lets take country A where i-phone is 100$ and another country B where i-phone is 200$, here the purchasing power of country A is double that of the country B with respect to i-phone.

The i-phone is a single product, to have meaningful calculation we add many goods and services eg:- electricity, milk, etc. Now this is called “basket of goods”.

For calculation, the currency of the nations A and B has been converted to common currency ie: dollar. The PPP can show the size of the country’s economy.

What are the criticisms of PPP model?

Let us assume that price of milk was compared between two countries

Country A  1litre = 2 dollar	Country B  I litre = 1 dollar
Milk is good quality, always preserved well, quality and safety tests done	Quality is poor, fluctuating with no quality tests, adulteration high.

Here though, you can buy double quantity of milk in country B, the quality defeats the quantity.

Similarly, Lets imagine B is a big country where a machinery is available at 500$ in city which is added in basket of goods. Now, a far-off villager buy this product from city and take it. The transport cost is high ( no good public transport, no great roads, high local area tax for new machinery etc) then the product costs villagers 700$ (500$ + 200$ transportation). These costs are not included in the PPP calculation.

There may be trade barriers, taxations etc. making goods/services unavailable/costly.

Thus, in-depth analysis are needed for accurate calculations.