Purchasing Power Parities
(PPPs) are simply price relatives that show the ratio of the prices in national
currencies of the same good or service in different countries. PPPs are also calculated for product
groups and for each of the various levels of aggregation up to and including
GDP. Thus, PPPs are the rates of
currency conversion that equalize the purchasing power of different currencies
by eliminating the differences in price levels between countries. And purchasing power parity conversion
factor is the number of units of a country's currency required to buy the same
amount of goods and services in the domestic market as a U.S. dollar would buy
in the United States. The ratio of PPP conversion factor to market exchange
rate is the result obtained by dividing the PPP conversion factor by the market
exchange rate. The ratio, also referred to as the national price level, makes
it possible to compare the cost of the bundle of goods that make up gross
domestic product (GDP) across countries. It tells how many dollars are needed
to buy a dollar's worth of goods in the country as compared to the United
States.
I.
The
first stage is at the product level, where price relatives are calculated for
individual goods and services. A simple example would be one litre of Pepsi. If
it costs 45.00 rupees in India and 2.00$ in the United States then the PPP for Pepsi
between India and the USA is 45/2.00, or 22.5. This means that for every dollar
spent on a litre of Pepsi in the USA, 22.5 rupees would have to be spent in India
to obtain the same quantity and quality - or, in other words, the same volume -
of Pepsi.
II.
The
second stage is at the product group level, where the price relatives
calculated for the products in the group are averaged to obtain un-weighted
PPPs for the group. Pepsi is for example included in the product group “Soft drinks
and Concentrates”.
III.
And
the third stage is at the aggregation levels, where the PPPs for the product
groups covered by the aggregation level are weighted and averaged to obtain
weighted PPPs for the aggregation level up to GDP (in our example, aggregated
levels are Non-alcoholic beverages, Food…). The weights used to aggregate the
PPPs in the third stage are the expenditures on the product groups as
established in the national accounts.
PPPs are being calculated by OECD for
the various countries. The basket of goods and services priced for the PPP
exercise is a sample of all goods and services covered by GDP. The final
product list covers around 3,000 consumer goods and services, 30 occupations in
government, 200 types of equipment goods and about 15 construction projects.
The large number of products is to enable countries to identify goods and
services which are representative of their domestic expenditures.
The major use of
PPPs is as a first step in making inter-country comparisons in real terms of
gross domestic product (GDP) and its component expenditures. GDP is the
aggregate used most frequently to represent the economic size of countries and,
on a per capita basis, the economic well-being of their residents. Calculating
PPPs is the first step in the process of converting the level of GDP and its
major aggregates, expressed in national currencies, into a common currency to
enable these comparisons to be made.
But the exchange rate is being used in
settling the trading of goods and services between the two countries and the
same is fixed by international markets. Also,
if we need to buy any thing in USA by INR, then we need to use exchange rate
for conversion. One may note that there are
wide variations between PPPs conversion rates and exchange rates. In the year 2008 as per world bank PPP
conversion rate between US dollar and Indian rupee is 0.4 and the exchange rate
(USD/INR) varied between 39 to 50 i.e. one dollar fetched about Rs. 44.5 on the
average, whereas for comparing the two economies one USD was taken equivalent
to Rs. 25. Thus, Indian economy worth
increases in dollar terms if PPP conversions rates are applied.
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