How to Determine Whether Purchasing Power Parity Exists
Purchasing power parity ("PPP") is an economic concept that means that the price paid in one currency is the equivalent price in a different currency for the same goods or services. If PPP exists, then as the exchange rate between two currencies fluctuates, the actual prices paid for goods and services during that time period will move proportionately. The biggest challenge to determining if PPP exists between two currencies is in selecting and collecting the right data about the comparable goods or services. While the exchange rates can be easily found in newspapers and on the internet, price information is harder to find.
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Instructions
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PPP STEPS
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Collect data on foreign exchange rates by checking newspapers such as the Wall Street Journal to find the exchange rate between the U.S. Dollar (USD) and the Great Britain Pound (GBP). For example, the rate on February 22, 2010 was $1.5476 per 1.00 GBP.
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Identify a basket of common goods and services, or a specific product. Ideally, the basket of goods and services should reflect the cost of living in both countries, and include items that can be purchased in both places. For example, for simplicity's sake, the monthly rent for similar apartments in London and in New York can be used. As an example, in London, the average rent for a small apartment is 1,300 GBP. In New York, a similar apartment rents for $2,974.
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Divide the rent number in dollars by the exchange rate. This is $2,974/$1.5476, or 1,922 GBP.
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Compare this number to the average rent in London. If it is the same, or close, then PPP exists. If it is higher or lower, then PPP does not exist. In this hypothetical case, 1,922 GBP is higher than 1,300 GBP, so PPP does not exist.
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