Purchasing power parity ( PPP ) is a neoclassical economic theory which states that the exchange rate between two countries equals the ratio of purchasing power of each currency. Theory that appeals to purchasing power parity assumes that in some circumstances (for example, as long-term trends), it costs exactly the same, for example, the US dollar to buy euros and then buy a basket of goods markets because it would cost to directly buy a basket of goods markets with dollars. Declining purchasing power of the currency will cause a proportional decline in the valuation of the currency in the foreign exchange market.
The concept of purchasing power parity allows one to estimate what exchange rate between two currencies should be for exchange to be equivalent to the purchasing power of the two countries' currencies. By using a PPP rate for hypothetical currency conversion, a certain amount of one currency thus has the same purchasing power, whether used directly to buy a goods market basket or used to convert at PPP rate to other currencies and then buy a market basket using the currency. Observed deviations in the exchange rate from the purchasing power parity are measured by deviations of the real exchange rate from the value of PPP 1.
The PPP exchange rate assists costing but excludes profits and above all does not consider the difference in quality of goods between countries. For example, suppose that two states produce the same amount of physical goods in each other every two different years. Because market exchange rates fluctuate substantially, when a country's GDP is measured in its own currency converted to another currency using a market exchange rate, one country may be inferred to have a higher real GDP than any other country in one year but another lower; these two conclusions will fail to reflect the reality of their relative production levels. But if a country's GDP is converted into another country's currency using the PPP exchange rate rather than the observed market exchange rate, false inference will not occur. In essence, PPP GDP controls for different living costs and price levels, usually relative to the US dollar, thus allowing more accurate depiction of a country's production level.
Video Purchasing power parity
Drafts
The idea originated from the Salamanca School in the 16th century, and developed in the modern form by Gustav Cassel in 1916, in the Current Situation of Foreign Trade. This concept is based on a one-price law, in the absence of transaction fees and official trade barriers, identical goods will have the same price in different markets when prices are expressed in the same currency.
Another interpretation is that the difference in the rate of domestic and foreign price changes - the difference in the rate of inflation - is equal to the percentage of depreciation or exchange rate appreciation.
The deviation from parity implies a difference in the purchasing power of the "basket of goods" in different countries, meaning that for many international comparison purposes, the country's GDP or other national income statistics need to be "adjusted PPP" and converted into public units.. The most famous purchasing power adjustment is the Geary-Khamis dollar ("international dollars"). The real exchange rate is then equal to the nominal exchange rate, adjusted for the difference in the price level. If the purchasing power parity is held exactly, then the real exchange rate will always be equal to one. However, in practice the real exchange rate denotes short- and long-term deviations from this value, for example for reasons illuminated in Balassa-Samuelson's theorem.
There can be marked differences between the purchasing power of the adjusted earnings and those that are converted through market exchange rates. For example, the World Bank World Development Indicators estimates that in 2003, a Geary-Khamis dollar was equivalent to about 1.8 Chinese yuan by purchasing power parity - very different from the nominal exchange rate. This distinction has major implications; for example, when converted through nominal exchange rates, per capita GDP in India is about US $ 1,965 while in PPP the base is about US $ 7,197. At the other extreme, for example Denmark's per capita nominal GDP is about US $ 53,242, but the PPP figure is 46.602 US dollars, in line with other developed countries.
Maps Purchasing power parity
Usage
The exchange rate purchasing power parity serves two main functions. PPP exchange rates can be useful for making comparisons between countries as they remain constant from day to day or week to week and only change little, if indeed, from year to year. Second, for several years, exchange rates tend to move in the general direction of the PPP exchange rate and there are some values ​​to know in which direction the exchange rate is more likely to shift in the long run.
Measurement
The controversial PPP exchange rate calculation is due to the difficulty of finding a comparable basket of goods to compare purchasing power between countries.
The estimated purchasing power parity is complicated by the fact that countries differ not only in uniform price levels; on the contrary, the difference in the price of food may be greater than the difference in the price of housing, while also less than the difference in the price of entertainment. People in different countries usually consume different basket of goods. You need to compare the cost of basket of goods and services using a price index. This is a difficult task because purchasing patterns and even items available for purchase differ in each country.
Thus, adjustments are needed for differences in the quality of goods and services. Furthermore, the basket of goods representing one economy will be different from the others: Americans eat more bread; More Chinese rice. Therefore the PPP calculated using US consumption as a base will be different from those calculated using China as the base. Additional statistical difficulties arise with a multilateral comparison when (as is usually the case) more than two countries should be compared.
Different ways of assessing bilateral KPS can provide a more stable multilateral comparison, but at the expense of bilateral distortions. These are all common issues of indexing; as with any other price index, there is no way to reduce the complexity to a single number which is equally satisfactory for all purposes. Nevertheless, PPPs are usually strong in the face of many emerging issues in using market exchange rates to make comparisons.
For example, in 2005 the price of one gallon of gasoline in Saudi Arabia was USD 0.91, and in Norway the price was USD 6.27. Significant price differences will not contribute to accuracy in PPP analysis, regardless of all the variables that contribute to significant price differences. More comparisons must be made and used as variables in the overall formulation of the PPP.
When PPP comparisons have to be made over several time intervals, the right account must be made of the inflation effect.
Legal one price
While it may seem as though PPP and law of one price are the same, there is a difference: the one price law applies to individual commodities whereas PPP applies to the general price level. If the law of one price applies to all commodities then the PPP is also true; however, when discussing the validity of PPP, some argue that one price law does not need to be true for PPP apply. If the law of one price does not apply to a particular commodity, the price level will not be quite different from the level predicted by PPP.
The purchasing power parity theory states that the exchange rate between one currency and another currency is in equilibrium when their domestic purchasing power is at equivalent exchange rates.
Big Mac Index
Another example of one legal measure of one price, underlying purchasing power parity, is the Big Mac Index, popularized by The Economist , which compares the price of Big Mac burgers at McDonald's restaurants in various countries. countries. The Big Mac index may be useful because even though it is based on a single consumer product that may not be typical, it is a relatively standard product that includes input costs from various sectors in the local economy, such as agricultural commodities (beef). , bread, lettuce, cheese), labor (blue and white collar), advertising, rent and real estate costs, transportation, etc.
In theory, the law of one price would state that if, for example, the Canadian dollar is significantly overvalued against the US dollar according to the Big Mac Index, the gap should not be sustainable as Canadians will import their Big Mac from or travel to the US for consuming it, causing demand pressure against the US dollar based on the Canadians who bought US dollars needed to buy US-made Big Macs and simultaneously put downward supply pressure on Canadian dollars based on Canadians selling their currency to buy the same US dollar.
The alternative to this exchange rate adjustment is price adjustment, with Canadian McDonald's shops pushed to lower prices to stay competitive. Either way, the difference in valuation should be reduced by the assumption of perfect competition and a perfectly tradable good. In practice, of course, the Big Mac is not a perfectly tradable item and there may also be capital flows that sustain the relative demand for the Canadian dollar. Price differences may come from a variety of factors other than direct input costs such as government regulations and product differentiation.
However, in some developing countries, Western fast food is an expensive niche product at prices well above traditional staple prices - that is. Big Mac is not a 'cheap' main meal like in the West, but imports are fancy. This relates back to the idea of ​​product differentiation: the fact that some substitutes for the Big Mac are available conferring market power on McDonald's. For example, in India, the cost of local fast food such as vada pav is comparable to what the Big Mac marks in the US. In addition, with countries like Argentina with abundant beef source, consumer prices in general may not be as cheap as implied by Big Mac prices.
The following table, based on data from the January Economy 's The Economist', shows the ratings below (-) and more () local currency against the US dollar in%, according to the Mac Big Index. To take for example, the local price of Big Mac in Hong Kong when converted to US dollars at market rate is $ 2.19, or 50% of the local price for the Big Mac in the US of $ 4.37. Therefore the Hong Kong dollar is considered 50% undervalued relative to US dollar based on PPP. iPad index
Like the Big Mac Index, the iPad index (described by CommSec) compares the price of a good in different locations. Unlike the Big Mac, however, every iPad is produced in the same place (except for models sold in Brazil) and all iPads (in the same model) have identical performance characteristics. Therefore, the price difference is a function of transportation costs, taxes, and prices that can be realized in individual markets. The iPad will cost twice as much in Argentina as in the United States.
KFC Index
Similar to the Big Mac Index, the KFC Index measures the PPP among African countries, created by Sagaci Research (a market research firm focusing solely on Africa). Instead of comparing Big Mac, this index compares KFC Original 12/15 pc. bucket.
For example, the average price of KFC's Original is 12 pc. Buckets in the United States in January 2016 were $ 20.50; while in Namibia it is only $ 13.40 with market rates. Therefore, the index declared the Namibian dollar undervalued by 33% at the time.
Gasoline
GlobalPetrolPrices has published two world rankings comparing petrol prices with average earnings and minimum wages.
OECD comparative price level
Each month, the Organization for Economic Cooperation and Development measures the difference in price levels among its member countries by calculating the PPP ratio for private final consumption expenditures for exchange rates. The OECD table below shows the amount of US dollars required in each listed country to purchase the same basket of goods and consumer services that will cost 100 USD in the United States.
According to the table, an American living or traveling in Switzerland with US dollar earnings will find the country as the most expensive group, should spend 62% more US dollars to maintain a standard of living comparable to the US. in terms of consumption.
Measurement issues
In addition to the methodological issues presented by the selection of a basket of goods, PPP estimates may also vary based on the statistical capacities of the participating countries. The International Comparison Program, based on PPP estimates, requires the division of national accounts into production, expenditure or (in some cases) revenue, and not all participating countries routinely separate their data into those categories.
Some aspects of PPP comparison are theoretically impossible or unclear. For example, there is no basis for comparison between Ethiopian workers living in teff with Thai workers living in rice, since teff is not commercially available in Thailand and rice is not in Ethiopia, so the price of rice in Ethiopia or teff in Thailand can not be determined. As a general rule, the more similar the price structure between countries, the more valid the PPP comparison.
The PPP level will also vary based on the formula used to calculate the price matrix. A variety of possible formulas include GEKS-Fisher, Geary-Khamis, IDB, and superlative methods. Each has advantages and disadvantages.
Linking areas presents other methodological difficulties. In the 2005 ICP round, the regions were compared with using a list of about 1,000 identical items whose prices could be found for 18 countries, selected so that at least two countries would be in each region. While this is superior to previous "bridging" methods, which do not fully account for the difference in quality between items, it may serve to overstate the PPP basis of poor countries, as PPP-based price indexing will set for the heavily handicapped poor countries larger that is consumed in larger portions in rich countries.
Need adjustment for GDP
The exchange rate reflects the value of transactions for traded goods between different countries and non-tradable goods, ie goods produced for use in the country of origin. Also, currencies are traded for purposes other than trade in goods and services, for example. , to buy capital assets whose prices vary more than physical goods. Also, different interest rates, speculation, hedging or intervention by the central bank may affect the foreign exchange market.
The PPP method is used as an alternative to correct the possibility of statistical bias. The Penn World Table is a widely cited source of PPP adjustments, and the associated Penn effects reflect a systematic bias in using exchange rates for output among countries.
For example, if the value of the Mexican peso drops by half compared with the US dollar, the Gross Domestic Product of Mexico measured in dollars will also be halved. However, this exchange rate is generated from international trade and financial markets. This does not mean that the Mexicans are half poorer; if the revenue and price measured in pesos remain the same, they will not be worse assuming that imported goods are not essential to the quality of life of the individual. Measuring income in different countries using PPP exchange rates helps to avoid this problem.
The PPP exchange rate is very useful when the official exchange rate is manipulated by the government. Countries with strong government control over the economy sometimes uphold the official exchange rate that makes their own currency very strong. In contrast, black currency market exchange rates are artificially weak. In such cases, the PPP exchange rate is probably the most realistic basis for economic comparison. Similarly, when exchange rates deviate significantly from their long-run equilibrium due to speculative attacks or trade carrying, the PPP exchange rate offers a better alternative for comparison.
PPP level extrapolation
Because global PPP estimates - as provided by ICP - are not calculated annually, but for one year, PPP exchange rates for years other than the benchmark year need to be extrapolated. One way to do this is to use the country's GDP deflator. To calculate a country's PPP exchange rate in Geary-Thurs dollars for a given year, the calculations take place in the following ways:
Where PPPrate X, i is the country's PPP exchange rate for year i, PPPrate X, b is the country's PPP exchange rate for the benchmark year, PPPrate U, b is the United States (US) PPP exchange rate for the benchmark year (equal to 1), GDPdef X, i is the country's GDP deflator X for year i, GDPdef X, b is the country's GDP deflator X for the benchmark year, GDPdef U, i is the US GDP deflator for year i, and GDPdef U, b is the US GDP deflator for the year benchmark.
Difficulty
There are a number of reasons that different sizes do not perfectly reflect the standard of living.
Product range and quality
Goods whose currency has "power" to buy are a basket of goods of various kinds:
- Local, non-tradable goods (such as electricity) produced and sold domestically.
- Tradable items such as non-perishable commodities that can be sold on international markets (such as diamonds).
The more products that fall into category 1, the further the price will be from the exchange rate, moving towards the PPP exchange rate. In contrast, product category 2 tends to trade near the exchange rate. (See also Penn effect).
More processed and expensive products tend to be traded, fall into the second category, and drift from PPP exchange rates to exchange rates. Even if the PPP "value" of the Ethiopian currency is three times stronger than the exchange rate, it will not buy three times as much international traded goods as steel, cars and microchips, but non-tradable items such as housing, services ("haircuts"), and domestic crops. The relative price difference between trade and non-trade from high-income countries to low-income countries is a consequence of the Balassa-Samuelson effect and provides a large cost advantage on the production of intensively tradable goods in low-income countries (such as Ethiopia) such as against high-income countries (such as Switzerland).
The cost advantage of firms is no more sophisticated than access to cheaper workers, but because workers pay further in low-income countries than high, relative salary (inter-state) differences can be sustained longer than will happen. if not. (This is another way of saying that wage rates are based on average local productivity and that this is below per capita productivity that factories selling goods that can be traded into international markets can achieve them.) The equivalent cost benefits come from goods, non-tradable goods that can be locally sourced (close to the PPP exchange rate rather than the nominal exchange rate at which the receipt is paid). It acts as a cheaper production factor than is available to manufacturers in rich countries. It is difficult by PPP GDP to consider differences in the quality of goods among different countries.
Bhagwati-Kravis-Lipsey's view provides a somewhat different explanation from Balassa-Samuelson's theory. This view holds that the price level for nontradables is lower in poorer countries due to differences in labor and capital endowments, not because of lower productivity levels. Poor countries have more labor than capital, so that marginal job productivity is greater in rich countries than in poor countries. Nontradables tend to be labor-intensive; therefore, because labor is cheaper in poorer countries and is used mostly for nontradables, nontradables is cheaper in poorer countries. High wages in rich countries, so nontradables are relatively more expensive.
PPP calculations tend to overemphasize major sectoral contributions, and less appreciate the contribution of industry and services to a country's economy.
Trade barriers and nontradables
The law of one price, the mechanism underlying the PPP, is weakened by the cost of transport and restrictions on government trade, which makes it costly to move goods between markets located in various countries. Transportation costs disconnect the exchange rate and the price of goods implied by the law of one price. As transportation costs increase, the greater the range of exchange rate fluctuations. The same is true for official trade restrictions because customs fees affect importers' profits in the same way as shipping costs. According to Krugman and Obstfeld, "One type of trade barrier undermines the basis of PPP by allowing the purchasing power of a particular currency to differ more widely from country to country." They cite the example that a dollar in London should buy the same thing as a dollar in Chicago, which of course is not the case.
Nontradables is primarily the service and output of the construction industry. Nontradables also causes irregularities in PPPs because nontradables prices are not internationally connected. The price is determined by the domestic supply and demand, and the shift in the curve causes a change in the market basket of some goods relative to the foreign price of the same basket. If the non-tradable price rises, the purchasing power of a particular currency will fall in that country.
Departure from free competition
The linkage between the national price level also weakens as trade barriers and imperfect competitive market structures coincide. Pricing for markets occurs when a company sells the same product for different prices in different markets. This is a reflection of the differences between countries on conditions on both sides of the demand ( eg , almost no demand for pork in Islamic countries) and the supply side ( for example , the existing market for prospective products has several or even near-saturated suppliers). According to Krugman and Obstfeld, the occurrence of this segmented product and market differentiation results in violations of the law of one price and absolute PPP. Over time, a shift in market structure and demand will occur, which can undo the relative PPP.
Differences in price level measurement
Price level measurement differs from country to country. Inflation data from various countries is based on different commodity baskets; therefore, exchange rate changes do not compensate for the official size of the inflation differential. Because it makes predictions about price changes rather than price levels, PPP is still a relatively useful concept. However, a change in the relative price of the cart component can lead to a relatively failed PPP test based on the official price index.
Global poverty line
The global poverty line is the number of people worldwide who live below the international poverty line, referred to as the dollar line per day. This line represents the average of the national poverty line of the world's poorest countries, expressed in international dollars. This national poverty line is converted into international currency and the global line is converted back into local currency using PPP exchange rates from ICP. The PPP exchange rate includes data from the sale of non-poverty-related goods that disrupt the value of food items and the required goods that constitute 70 percent of the consumption of the poor. Angus Deaton argues that the PPP index needs to be revisited for use in poverty measurement; they need to be redefined to reflect local poverty measures, not global measures, weighing local food items and excluding unusual or unfamiliar luxury items in all regions.
See also
- List of countries by GDP (PPP)
- List of countries based on per capita GDP (PPP)
- List of IMF ranking countries by GDP, Including PPP ranked IMF from 186 countries
- Measures of national income and output
- Relative purchasing power parity
References
External links
- Penn World Table
- Purchasing power parity updated by OECD from OECD data
- Explanation from U. British Columbia (also provides updated daily PPP chart)
- Purchase power parity as an example of international statistical cooperation from Eurostat - Statistics Explained
- The World Bank's International Comparison Project provides PPP estimates for a large number of countries
- UBS 2006 "Price and Revenue" Report A good report on purchasing power that contains the Big Mac index and basic items such as bread and rice for 71 world cities.
- "Understanding PPP and PPP-based national accounts" provides an overview of methodological issues in calculating PPP and in designing ICP where the main PPP tables (Maddison, Penn World Tables, and World Bank WDI) are based.
- List of Countries by Purchasing Power Parity since 1990 (World Bank)
Source of the article : Wikipedia
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