PURCHASING POWER PARITY

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• PURCHASING POWER PARITY
• Theory that exchange rates should adjust to
  equalize the cost of goods in different countries.

Based on information provided by Astrid DeBruyn
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Purchasing Power Parity

• Purchasing PowerHow much your money will buy
• ParityEquality
• Put it all together
• Equal value of money
• Money should buy the same amount of goods and
  services in different currencies

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Purchasing Power Parity

• ASSUMPTIONS
• Product / service essentially the same
• Product / service is tradable
• Free trade in global market
• Ignore transportation costs

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Purchasing Power Parity

• EXAMPLE
• Basic digital camera
• Sells for
• 29.99 in the US
• 2500 yen in Japan
• 25 pounds sterling in UK
• Where does it cost least? Most?

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Purchasing Power Parity

• Depends on the exchange rates
• Japan cheapest, UK most expensive
• Yen is undervalued, Pound overvalued

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• Purchasing Power Parity Theory
• states that in the long run, exchange rates will
  adjust so that goods will cost the same in every
  country.

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Big Mac Index - The Economist magazine -
100 countries - US price of Big Macs
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The Big Mac index was devised 13 years ago as a
light-hearted guide to whether currencies are at
their correct level. Our basket is a
McDonalds Big Mac, which is produced in more
than 100 countries. Comparing actual exchange
rates with PPPs signals whether a currency is
under- or over-valued.The Economist, April 1,
1999