Purchasing power parity

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What is purchasing power parity (PPP)?

Each country describes their economic data, such as Gross Domestic Product (GDP), GDP per Capita, income or poverty, in their own currency. In order to make comparisons among countries, all of the currencies have to be made equivalent, This is most commonly done by making the national currencies comparable to the US dollar, by figuring out how many local currency units (e.g., pounds, francs, yen) it would take to buy what could be bought with one US dollar. Then comparisons could be made between countries.

For example, suppose we look at annual GDP in the US, Russia and Japan.

Table 1 Annual GDP 2008 National Currencies^[1]
US	14.4 billion US dollars
Russia	41.7 billion Russian rubles
Japan	505.1 billion Japan yen

On the other hand, if these were all expressed in a common currency, like the US dollar, then we could compare across countries.

Table 2 Annual GDP, 2008 US Dollars^[2]
US	14.4 billion US dollars
Russia	2.9 billion US dollars
Japan	4.3 billion US dollars

Now we can see that the US has the largest economy, followed by Japan and then by Russia.

We can compare the countries when they are all expressed in the same currency. The purchasing power parity (PPP) is the tool we use to convert each national currency to US dollars.

How to make all the currencies "equal"

The basic idea is for each country to find prices for a 'basket' of goods and services that represents their economy, measured in their own currency. Then the price of the 'basket', in local currency, is compared to the price of the same 'basket' of goods and services in a base country, say the USA.

The ratio of the price of the 'basket' in local currency to the price of the same 'basket' in US dollars, is the PPP.

For example, in 2008, representative 'baskets' of goods in Russia and Japan show PPPs for Russia and Japan.

Table 3 Purchasing Power Parities^[3]
	Cost of basket in local currency	Cost of basket in US$	PPP
Russia	100 rubles	$6.98	14.33
Japan	100 yen	$0.85	117.03

So a 'basket' of goods that cost 100 rubles in Russia would cost, in the US, about 7$. Similarly, a basket that costs 100 yen in Japan, would cost, in the US, 85 cents.

The PPP is similarly used to calculate many economic indicators in common dollars, such as the size of the economy, average income per capita, the percent of people in poverty (for example, percent of people with incomes under $1 a day), and income inequality.

Table 4, below, shows how the PPP is used to calculate national GDP in US dollars.

Table 4 Using PPP^[4]
	GDP in local currency	PPP	GDP in US$
Russia	41.7 billion rubles	14.3	$2.9 billion
Japan	505.1 billion yen	117.03	$4.3 billion

Thus, 41.7 billion rubles (Russian rubles) divided by 14.3 = $2.9 billion (US dollars) and 505.1 billion yen (Japan currency) divided by 117.03 = $4.3 billion (US dollars).

External links

International Comparison Program (ICP) 2011 Round The IPC is a worldwide statistical partnership to collect comparative price data and compile detailed expenditure values of countries’ gross domestic products (GDP), and to estimate purchasing power parities (PPPs) of the world’s economies.

OECD's Purchasing Power Parity page

Sources

Gross Domestic Product. Citizendium entry. 2008.

Paul Schreyer and Francette Koechlin. Statistical Brief, N. 3 - March 2002 - Purchasing power parities - measurement and uses.

References

↑ Data from OECD Stats Extracts. National Accounts. Gross Domestic Product (output approach). Measured by national currency, current prices. Copyright by OECD http://stats.oecd.org/Index.aspx Data retrieved 11/14/2010

↑ Data from OECD Stats Extracts. National Accounts. Gross Domestic Product (output approach). Measured by US$, current prices, current PPPs. Copyright by OECD http://stats.oecd.org/Index.aspx Data retrieved 11/14/2010

↑ PPP from OECD Stats Extracts. National Accounts. PPPGDP, Purchasing Power Parity for GDP, National Currency per US Dollar. Copyright by OECD http://stats.oecd.org/Index.aspx Data retrieved 11/21/2010. Cost in US$ calculated by Dr. Shackman.

↑ GDP data from OECD Stats Extracts. National Accounts. Gross Domestic Product (output approach). Measured by national currency, current prices. Copyright by OECD http://stats.oecd.org/Index.aspx Data retrieved 11/14/2010