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What is Purchasing Power Parity? Why Bread Costs Rs 45 in India and In US Cost 2$ (Rs 166)

Updated: Dec 7, 2023

What is Purchase Power Parity?

Purchasing power parity (PPP) is an economic term which is used for comparison (of prices, economic performance and growth, standard of living) using a common currency or basket of goods method.

For example, a loaf of bread costs $2 in US which will be around Rs. 166 and the same bread will cost in India around Rs. 40. Similarly, a chocolate may cost around Rs. 50 in India whereas the same chocolate will cost more than a dollar which is around 1US$ Rs. 80 in US. After converting both the prices in the same currency comparison can be done easily for deriving conclusions.

As per this theory, a basket of goods will comprise the same price in both countries after being converted to the same currency. For instance, if a basket of goods is priced at Rs. 1000, the dollar price in the US will also be equal to Rs. 1000 after the conversion of currency from dollar to rupee. However, this theory does not hold true in the practical aspect. Let’s take gold for an example, gold prices are different in India and Dubai, similarly, oil and gas prices are different in different countries.

Reasons for Difference in Value of Goods across countries

1. Transportation costs: Goods that are supplied locally or domestically incurs low transportation cost whereas goods that are imported have relatively higher transportation cost. Accordingly, the cost and price of product varies in different countries.

2. Tax & Subsidy Regulations: Distinctive countries have differing tax regulations such as taxation rates, type of taxes, goods and services that are taxed or non-taxed and so on. Similarly, there may be subsidy on the production or sale of certain goods or services in certain countries. These regulations create a difference in the cost of the product and thereby price of the product.

3. Non-Traded Goods & Services: Goods that are not traded across borders create differences in the prices of those goods and services leading to deviations from PPP.

4.Government Interventions: Government interventions such as monetary policies and exchange rate interventions can affect the price of goods and services deviating from PPP.

5. Speculative Activities: Speculative Activities in the forex market can induce volatility in the market leading to fluctuation in exchange rates and thereby prices of the Purchase Power Parity.

6. Market Competition: The level of competition in the country can also affect the prices of goods and services. For example, in the case of a monopoly, prices will be higher in the monopoly country.

Purchase power parity allows for comparison among various countries with diverse countries, however, it is not a perfect measurement tool but at the same time it makes measurement and comparison relatively easier and simple to perform.

Real GDP V/s Nominal GDP

Due to large differences in price levels across economies, market exchange rate converted GDP does not accurately measure the relative sizes of economies and the levels of material well-being. PPPs make it possible to compare the output of economies and the welfare of their inhabitants in ‘real’ terms, thus controlling for price level differences across countries. The preceding table lists 12 economies with the largest share of world GDP in PPP terms, and the corresponding shares using market exchange rates in 2011. Below images illustrates

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