Unit 2 & 4: Purchasing Power Parity

With the unit 2 and theme 2 exams approaching, it is essential to have some background on the usefulness of PPP when comparing GDP between countries.

Since market exchange rates are usually influenced by the forces of supply and demand, and they cause the appreciation or depreciation of a currency. The exchange rate though determined only through the market, is not accurate in demonstrating purchasing power of peoples’ income in different countries.

The PPP is calculated by comparing the price of a basket of comparable goods and services in different countries.

It allows you to compare the price of household items in different countries.

To make comparison between countries meaningful you need a way of comparing exchange rates between countries which compares the cost of living in those countries.

If you are given a question in your upcoming exams relating to the PPP here is a way of demonstrating your understanding:

Let’s say a basket of the same goods and services is worth $100 in the US and the same basket of goods is worth €130 in Cyprus.