Purchasing power parity (PPP) is an economic theory that compares different countries’ currencies through a “basket of goods” approach, not to be confused with the Paycheck Protection Program created by the CARES Act. It allows economists to compare economic productivity and standards of living between countries.
Comparing Nations’ Purchasing Power Parity
To make a meaningful comparison of prices across countries, a wide range of goods and services must be considered.
- International Comparison Program (ICP)
- Helps international macroeconomists estimate global productivity and growth
- Every few years, the World Bank releases a report that compares the productivity & growth of various countries in terms of PPP and U.S. dollars
- Both the IMF and the OECD use weights based on PPP metrics to make predictions & recommend economic policy.
Pairing Purchasing Power Parity With Gross Domestic Product
In contemporary macroeconomics, gross domestic product (GDP) refers to the total monetary value of the goods and services produced within one country
- Nominal GDP calculates the monetary value in current, absolute terms
- Real GDP adjusts nominal GDP for inflation
- Purchasing power parity makes GDP more easily comparable between countries with different currencies
Drawbacks of Purchasing Power Parity
Since 1986, The Economist has playfully tracked the price of McDonald’s Big Mac hamburger across many countries.
- Their study results in the famed “Big Mac Index.”
- In a prominent 2003 paper, PPP-authors Michael R. Pakko and Patricia S. Pollard cited the following factors to explain why the purchasing power parity theory is not a good reflection of reality.
