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Purchasing power parity (PPP) is a way of measuring economic variables in different countries so that irrelevant exchange rate variations do not distort comparisons. Purchasing power exchange rates are such that it would cost exactly the same number of, for example, US dollars to buy euros and then buy a basket of goods in the market as it would cost to purchase the same goods directly with dollars. The purchasing power exchange rate used in this conversion equals the ratio of the currencies' respective purchasing powers (reciprocals of their price levels).

The euro is the official currency of 19 of the 28 member states of the European Union. This group of states is known as the eurozone or euro area, and counts about 343 million citizens as of 2019. The euro is the second largest and second most traded currency in the foreign exchange market after the United States dollar. The euro is divided into 100 cents.

Purchasing power is the amount of goods and services that can be purchased with a unit of currency. For example, if one had taken one unit of currency to a store in the 1950s, it would have been possible to buy a greater number of items than would be the case today, indicating that the currency had a greater purchasing power in the 1950s. Currency can be either a commodity money, like gold or silver, or fiat money emitted by government sanctioned agencies.

The general price level is a hypothetical daily measure of overall prices for some set of goods and services, in an economy or monetary union during a given interval, normalized relative to some base set. Typically, the general price level is approximated with a daily price index, normally the Daily CPI. The general price level can change more than once per day during hyperinflation.

## Contents

In neoclassical economic theory, the purchasing power parity theory assumes that the exchange rate between two currencies actually observed in the foreign exchange market is the one that is used in the purchasing power parity comparisons, so that the same amount of goods could actually be purchased in either currency with the same beginning amount of funds. Depending on the particular theory, purchasing power parity is assumed to hold either in the long run or, more strongly, in the short run. Theories that invoke purchasing power parity assume that in some circumstances a fall in either currency's purchasing power (a rise in its price level) would lead to a proportional decrease in that currency's valuation on the foreign exchange market.

Neoclassical economics is an approach to economics focusing on the determination of goods, outputs, and income distributions in markets through supply and demand. This determination is often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits by firms facing production costs and employing available information and factors of production, in accordance with rational choice theory, a theory that has come under considerable question in recent years.

The foreign exchange market is a global decentralized or over-the-counter (OTC) market for the trading of currencies. This market determines the foreign exchange rate. It includes all aspects of buying, selling and exchanging currencies at current or determined prices. In terms of trading volume, it is by far the largest market in the world, followed by the Credit market.

The concept of purchasing power parity allows one to estimate what the exchange rate between two currencies would have to be to equate the purchasing power of the two currencies. Observed deviations of the exchange rate from purchasing power parity are measured by deviations of the real exchange rate from its PPP value.

PPP exchange rates help costing but exclude profits and above all do not consider the different quality of goods among countries. The same product, for instance, can have a different level of quality and even safety in different countries, and may be subject to different taxes and transport costs. Since market exchange rates fluctuate substantially, when the GDP of one country measured in its own currency is converted to the other country's currency using market exchange rates, one country might be inferred to have higher real GDP than the other country in one year but lower in the other; both of these inferences would fail to reflect the reality of their relative levels of production. But if one country's GDP is converted into the other country's currency using PPP exchange rates instead of observed market exchange rates, the false inference will not occur. Essentially GDP measured at PPP controls for the different costs of living and price levels, usually relative to the United States dollar, enabling a more accurate estimate of a nation's level of production.

In business, engineering, and manufacturing, quality has a pragmatic interpretation as the non-inferiority or superiority of something; it's also defined as being suitable for its intended purpose while satisfying customer expectations. Quality is a perceptual, conditional, and somewhat subjective attribute and may be understood differently by different people. Consumers may focus on the specification quality of a product/service, or how it compares to competitors in the marketplace. Producers might measure the conformance quality, or degree to which the product/service was produced correctly. Support personnel may measure quality in the degree that a product is reliable, maintainable, or sustainable.

## Concept

The idea originated with the School of Salamanca in the 16th century, and was developed in its modern form by Gustav Cassel in 1916, in The Present Situation of the Foreign Trade. [1] [2] While Gustav Cassel’s use of PPP concept has been traditionally interpreted as his attempt to formulate a positive theory of exchange rate determination, the policy and theoretical context in which Cassel wrote about exchange rates suggests different interpretation.  In the years immediately preceding the end of WWI and following it economists and politicians were involved in discussions on possible ways of restoring the gold standard, which would automatically restore the system of fixed exchange rates among participating nations.  The stability of exchange rates was widely believed to be crucial for restoring the international trade and for its further stable and balanced growth.  Nobody then was mentally prepared for the idea that flexible exchange rates determined by market forces do not necessarily cause chaos and instability in the peaceful time (and that is what the abandoning of the gold standard during the war was blamed for).  Gustav Cassel was among those who supported the idea of restoring the gold standard, although with some alterations.  The question, which Gustav Cassel tried to answer in his works written during that period, was not how exchange rates are determined in the free market, but rather how to determine the appropriate level at which exchange rates were to be fixed during the restoration of the system of fixed exchange rates.  His recommendation was to fix exchange rates at the level corresponding to the PPP, as he believed that this would prevent trade imbalances between trading nations.  Thus, PPP doctrine proposed by Cassel was not really a positive theory of exchange rate determination (as Cassel was perfectly aware of numerous factors that prevent exchange rates from stabilizing at PPP level if allowed to float), but rather a normative policy advice, formulated in the context of discussions on returning to the gold standard [3] .

The School of Salamanca is the Renaissance of thought in diverse intellectual areas by Spanish and Portuguese theologians, rooted in the intellectual and pedagogical work of Francisco de Vitoria. From the beginning of the 16th century the traditional Catholic conception of man and of his relation to God and to the world had been assaulted by the rise of humanism, by the Protestant Reformation and by the new geographical discoveries and their consequences. These new problems were addressed by the School of Salamanca. The name refers to the University of Salamanca, where de Vitoria and other members of the school were based.

Karl Gustav Cassel was a Swedish economist and professor of economics at Stockholm University.

A gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. Three types can be distinguished: specie, bullion, and exchange.

The PPP concept is based on the law of one price, where in the absence of transaction costs and official trade barriers, identical goods will have the same price in different markets when the prices are expressed in the same currency. [4]

The law of one price (LOOP) states that in the absence of trade frictions, and under conditions of free competition and price flexibility, identical goods sold in different locations must sell for the same price when prices are expressed in a common currency. This law is derived from the assumption of the inevitable elimination of all arbitrage.

In economics and related disciplines, a transaction cost is a cost in making any economic trade when participating in a market.

Another interpretation is that the difference in the rate of change in prices at home and abroad—the difference in the inflation rates—is equal to the percentage depreciation or appreciation of the exchange rate.

Deviations from parity imply differences in purchasing power of a "basket of goods" across countries, which means that for the purposes of many international comparisons, countries' GDPs or other national income statistics need to be "PPP-adjusted" and converted into common units. The best-known purchasing power adjustment is the Geary–Khamis dollar (the "international dollar"). The real exchange rate is then equal to the nominal exchange rate, adjusted for differences in price levels. If purchasing power parity held exactly, then the real exchange rate would always equal one. However, in practice the real exchange rates exhibit both short run and long run deviations from this value, for example due to reasons illuminated in the Balassa–Samuelson theorem.

There can be marked differences between purchasing power adjusted incomes and those converted via market exchange rates. [5] For example, the World Bank's World Development Indicators 2005 estimated that in 2003, one Geary-Khamis dollar was equivalent to about 1.8 Chinese yuan by purchasing power parity [6] —considerably different from the nominal exchange rate. This discrepancy has large implications; for instance, when converted via the nominal exchange rates GDP per capita in India is about US$1,965 [7] while on a PPP basis it is about US$7,197. [8] At the other extreme, for instance Denmark's nominal GDP per capita is around US$53,242, but its PPP figure is US$46,602, in line with other developed nations.

## Uses

The purchasing power parity exchange rate serves two main functions. PPP exchange rates can be useful for making comparisons between countries because they stay fairly constant from day to day or week to week and only change modestly if at all, from year to year. Second, over a period of years, exchange rates do tend to move in the general direction of the PPP exchange rate and there is some value to knowing in which direction the exchange rate is more likely to shift over the long run.

## Measurement

The PPP exchange-rate calculation is controversial because of the difficulties of finding comparable baskets of goods to compare purchasing power across countries. [9] [ citation needed ]

Estimation of purchasing power parity is complicated by the fact that countries do not simply differ in a uniform price level; rather, the difference in food prices may be greater than the difference in housing prices, while also less than the difference in entertainment prices. People in different countries typically consume different baskets of goods. It is necessary to compare the cost of baskets of goods and services using a price index. This is a difficult task because purchasing patterns and even the goods available to purchase differ across countries.

Thus, it is necessary to make adjustments for differences in the quality of goods and services. Furthermore, the basket of goods representative of one economy will vary from that of another: Americans eat more bread; Chinese more rice. Hence a PPP calculated using the US consumption as a base will differ from that calculated using China as a base. Additional statistical difficulties arise with multilateral comparisons when (as is usually the case) more than two countries are to be compared.

Various ways of averaging bilateral PPPs can provide a more stable multilateral comparison, but at the cost of distorting bilateral ones. These are all general issues of indexing; as with other price indices there is no way to reduce complexity to a single number that is equally satisfying for all purposes. Nevertheless, PPPs are typically robust in the face of the many problems that arise in using market exchange rates to make comparisons.

For example, in 2005 the price of a gallon of gasoline in Saudi Arabia was US$0.91, and in Norway the price was US$6.27. [10] The significant differences in price would not contribute to accuracy in a PPP analysis, despite all of the variables that contribute to the significant differences in price. More comparisons have to be made and used as variables in the overall formulation of the PPP.

When PPP comparisons are to be made over some interval of time, proper account needs to be made of inflationary effects.

### Law of one price

Although it may seem as if PPPs and the law of one price are the same, there is a difference: the law of one price applies to individual commodities whereas PPP applies to the general price level. If the law of one price is true for all commodities then PPP is also therefore true; however, when discussing the validity of PPP, some argue that the law of one price does not need to be true exactly for PPP to be valid. If the law of one price is not true for a certain commodity, the price levels will not differ enough from the level predicted by PPP. [11]

The purchasing power parity theory states that the exchange rate between one currency and another currency is in equilibrium when their domestic purchasing powers at that rate of exchange are equivalent.

### Big Mac Index

Another example of one measure of the law of one price, which underlies purchasing power parity, is the Big Mac Index, popularized by The Economist , which compares the prices of a Big Mac burger in McDonald's restaurants in different countries. The Big Mac Index is presumably useful because although it is based on a single consumer product that may not be typical, it is a relatively standardized product that includes input costs from a wide range of sectors in the local economy, such as agricultural commodities (beef, bread, lettuce, cheese), labor (blue and white collar), advertising, rent and real estate costs, transportation, etc.

In theory, the law of one price would hold that if, to take an example, the Canadian dollar were to be significantly overvalued relative to the U.S. dollar according to the Big Mac Index, that gap should be unsustainable because Canadians would import their Big Macs from or travel to the U.S. to consume them, thus putting upward demand pressure on the U.S. dollar by virtue of Canadians buying the U.S. dollars needed to purchase the U.S.-made Big Macs and simultaneously placing downward supply pressure on the Canadian dollar by virtue of Canadians selling their currency in order to buy those same U.S. dollars. [12] [13] [ citation needed ]

The alternative to this exchange rate adjustment would be an adjustment in prices, with Canadian McDonald's stores compelled to lower prices to remain competitive. Either way, the valuation difference should be reduced assuming perfect competition and a perfectly tradable good. In practice, of course, the Big Mac is not a perfectly tradable good and there may also be capital flows that sustain relative demand for the Canadian dollar. The difference in price may have its origins in a variety of factors besides direct input costs such as government regulations and product differentiation. [11]

In some emerging economies, Western fast food represents an expensive niche product priced well above the price of traditional staples—i.e. the Big Mac is not a mainstream 'cheap' meal as it is in the West, but a luxury import. This relates back to the idea of product differentiation: the fact that few substitutes for the Big Mac are available confers market power on McDonald's. For example, in India, the costs of local fast food like vada pav are comparative to what the Big Mac signifies in the U.S. [14] Additionally, with countries such as Argentina that have abundant beef resources, consumer prices in general may not be as cheap as implied by the price of a Big Mac.

The following table, based on data from The Economist's January 2013 calculations, shows the under (−) and over (+) valuation of the local currency against the U.S. dollar in %, according to the Big Mac index. To take an example calculation, the local price of a Big Mac in Hong Kong when converted to U.S. dollars at the market exchange rate was $2.19, or 50% of the local price for a Big Mac in the U.S. of$4.37. Hence the Hong Kong dollar was deemed to be 50% undervalued relative to the U.S. dollar on a PPP basis.

Country or regionPrice level (% change with the US) [15]
India-58
South Africa-54
Hong Kong-50
Ukraine-47
Egypt-45
Russia-45
Taiwan-42
China-41
Malaysia-41
Sri Lanka-37
Indonesia-35
Mexico-34
Philippines-33
Poland-33
Saudi Arabia-33
Thailand-33
Pakistan-32
Lithuania-30
Latvia-25
UAE-25
South Korea-22
Japan-20
Singapore-17
Estonia-16
Czech Republic-15
Argentina-13
Hungary-13
Peru-11
Israel-8
Portugal-8
United Kingdom-3
New Zealand-1
Chile0
United States0 (by definition)
Costa Rica+1
Greece+3
Austria+5
Netherlands+7
Ireland+8
Spain+9
Turkey+10
Colombia+11
Australia+12
Euro area+12
France+12
Germany+13
Finland+17
Belgium+18
Denmark+19
Italy+20
Uruguay+25
Brazil+29
Switzerland+63
Sweden+75
Norway+80
Venezuela+108

Like the Big Mac Index, the iPad index (elaborated by CommSec) compares an item's price in various locations. Unlike the Big Mac, however, each iPad is produced in the same place (except for the model sold in Brazil) and all iPads (within the same model) have identical performance characteristics. Price differences are therefore a function of transportation costs, taxes, and the prices that may be realized in individual markets. An iPad will cost about twice as much in Argentina as in the United States.

Country or regionPrice (US Dollars) [16] [17] [18] [19]
Argentina$1,094.11 Australia$506.66
Austria$674.96 Belgium$618.34
Brazil$791.40 Brunei$525.52
Canada (Montréal)$557.18 Canada (no tax)$467.36
Chile$602.13 China$602.52
Czech Republic$676.69 Denmark$725.32
Finland$695.25 France$688.49
Germany$618.34 Greece$715.54
Hong Kong$501.52 Hungary$679.64
India$512.61 Ireland$630.73
Italy$674.96 Japan$501.56
Luxembourg$641.50 Malaysia$473.77
Mexico$591.62 Netherlands$683.08
New Zealand$610.45 Norway$655.92
Philippines$556.42 Pakistan$550.00
Poland$704.51 Portugal$688.49
Russia$596.08 Singapore$525.98
Slovakia$674.96 Slovenia$674.96
South Africa$559.38 South Korea$576.20
Spain$674.96 Sweden$706.87
Switzerland$617.58 Taiwan$538.34
Thailand$530.72 Turkey$656.96
UAE$544.32 United Kingdom$638.81
US (California)$546.91 United States (no tax)$499.00
Vietnam$554.08 ### KFC Index Similar to the Big Mac Index, the KFC Index measures PPP amongst African countries, created by Sagaci Research (a market research firm focusing solely on Africa). Instead of comparing a Big Mac, this index compares a KFC Original 12/15 pc. bucket. For example, the average price of KFC's Original 12 pc. Bucket in the United States in January 2016 was$20.50; while in Namibia it was only $13.40 at market exchange rates. Therefore, the index states the Namibian dollar was undervalued by 33% at that time. ### OECD comparative price levels Each month, the Organisation for Economic Co-operation and Development measures the difference in price levels between its member countries by calculating the ratios of PPPs for private final consumption expenditure to exchange rates. The OECD table below indicates the number of US dollars needed in each of the countries listed to buy the same representative basket of consumer goods and services that would cost US$100 in the United States

According to the table, an American living or travelling in Switzerland on an income denominated in US dollars would find that country to be the most expensive of the group, having to spend 62% more US dollars to maintain a standard of living comparable to the US in terms of consumption.

CountryPrice level (US = 100) [20]
Australia123
Austria99
Belgium101
Chile67
Czech Republic59
Denmark128
Estonia71
Finland113
France100
Germany94
Greece78
Hungary52
Iceland111
Ireland109
Israel109
Italy94
Japan96
South Korea84
Luxembourg112
Mexico66
Netherlands102
New Zealand118
Norway134
Poland51
Portugal73
Slovak Republic63
Slovenia75
Spain84
Sweden109
Switzerland162
Turkey61
United Kingdom121
United States100

### Measurement issues

In addition to methodological issues presented by the selection of a basket of goods, PPP estimates can also vary based on the statistical capacity of participating countries. The International Comparison Program, which PPP estimates are based on, require the disaggregation of national accounts into production, expenditure or (in some cases) income, and not all participating countries routinely disaggregate their data into such categories.

Some aspects of PPP comparison are theoretically impossible or unclear. For example, there is no basis for comparison between the Ethiopian laborer who lives on teff with the Thai laborer who lives on rice, because teff is not commercially available in Thailand and rice is not in Ethiopia, so the price of rice in Ethiopia or teff in Thailand cannot be determined. As a general rule, the more similar the price structure between countries, the more valid the PPP comparison.

PPP levels will also vary based on the formula used to calculate price matrices. Different possible formulas include GEKS-Fisher, Geary-Khamis, IDB, and the superlative method. Each has advantages and disadvantages.

Linking regions presents another methodological difficulty. In the 2005 ICP round, regions were compared by using a list of some 1,000 identical items for which a price could be found for 18 countries, selected so that at least two countries would be in each region. While this was superior to earlier "bridging" methods, which do not fully take into account differing quality between goods, it may serve to overstate the PPP basis of poorer countries, because the price indexing on which PPP is based will assign to poorer countries the greater weight of goods consumed in greater shares in richer countries.

## Need for adjustments to GDP

The exchange rate reflects transaction values for traded goods between countries in contrast to non-traded goods, that is, goods produced for home-country use. Also, currencies are traded for purposes other than trade in goods and services, e.g., to buy capital assets whose prices vary more than those of physical goods. Also, different interest rates, speculation, hedging or interventions by central banks can influence the foreign-exchange market.

The PPP method is used as an alternative to correct for possible statistical bias. The Penn World Table is a widely cited source of PPP adjustments, and the associated Penn effect reflects such a systematic bias in using exchange rates to outputs among countries.

For example, if the value of the Mexican peso falls by half compared to the US dollar, the Mexican Gross Domestic Product measured in dollars will also halve. However, this exchange rate results from international trade and financial markets. It does not necessarily mean that Mexicans are poorer by a half; if incomes and prices measured in pesos stay the same, they will be no worse off assuming that imported goods are not essential to the quality of life of individuals. Measuring income in different countries using PPP exchange rates helps to avoid this problem.

PPP exchange rates are especially useful when official exchange rates are artificially manipulated by governments. Countries with strong government control of the economy sometimes enforce official exchange rates that make their own currency artificially strong. By contrast, the currency's black market exchange rate is artificially weak. In such cases, a PPP exchange rate is likely the most realistic basis for economic comparison. Similarly, when exchange rates deviate significantly from their long term equilibrium due to speculative attacks or carry trade, a PPP exchange rate offers a better alternative for comparison.

### Extrapolating PPP rates

Since global PPP estimates—such as those provided by the ICP— are not calculated annually, but for a single year, PPP exchange rates for years other than the benchmark year need to be extrapolated. [21] One way of doing this is by using the country's GDP deflator. To calculate a country's PPP exchange rate in Geary–Khamis dollars for a particular year, the calculation proceeds in the following manner: [22]

${\displaystyle {\textrm {PPPrate}}_{X,i}={\frac {{\textrm {PPPrate}}_{X,b}\cdot {\frac {{\textrm {GDPdef}}_{X,i}}{{\textrm {GDPdef}}_{X,b}}}}{{\textrm {PPPrate}}_{U,b}\cdot {\frac {{\textrm {GDPdef}}_{U,i}}{{\textrm {GDPdef}}_{U,b}}}}}}$

Where PPPrateX,i is the PPP exchange rate of country X for year i, PPPrateX,b is the PPP exchange rate of country X for the benchmark year, PPPrateU,b is the PPP exchange rate of the United States (US) for the benchmark year (equal to 1), GDPdefX,i is the GDP deflator of country X for year i, GDPdefX,b is the GDP deflator of country X for the benchmark year, GDPdefU,i is the GDP deflator of the US for year i, and GDPdefU,b is the GDP deflator of the US for the benchmark year.

## Difficulties

There are a number of reasons that different measures do not perfectly reflect standards of living.

### Range and quality of goods

The goods that the currency has the "power" to purchase are a basket of goods of different types:

1. Local, non-tradable goods and services (like electric power) that are produced and sold domestically.
2. Tradable goods such as non-perishable commodities that can be sold on the international market (like diamonds).

The more that a product falls into category 1, the further its price will be from the currency exchange rate, moving towards the PPP exchange rate. Conversely, category 2 products tend to trade close to the currency exchange rate. (See also Penn effect).

More processed and expensive products are likely to be tradable, falling into the second category, and drifting from the PPP exchange rate to the currency exchange rate. Even if the PPP "value" of the Ethiopian currency is three times stronger than the currency exchange rate, it won't buy three times as much of internationally traded goods like steel, cars and microchips, but non-traded goods like housing, services ("haircuts"), and domestically produced crops. The relative price differential between tradables and non-tradables from high-income to low-income countries is a consequence of the Balassa–Samuelson effect and gives a big cost advantage to labour-intensive production of tradable goods in low income countries (like Ethiopia), as against high income countries (like Switzerland).

The corporate cost advantage is nothing more sophisticated than access to cheaper workers, but because the pay of those workers goes farther in low-income countries than high, the relative pay differentials (inter-country) can be sustained for longer than would be the case otherwise. (This is another way of saying that the wage rate is based on average local productivity and that this is below the per capita productivity that factories selling tradable goods to international markets can achieve.) An equivalent cost benefit comes from non-traded goods that can be sourced locally (nearer the PPP-exchange rate than the nominal exchange rate in which receipts are paid). These act as a cheaper factor of production than is available to factories in richer countries. It's difficult by the GDP PPP to consider the different quality of goods among the different countries.

The Bhagwati–Kravis–Lipsey view provides a somewhat different explanation from the Balassa–Samuelson theory. This view states that price levels for nontradables are lower in poorer countries because of differences in endowment of labor and capital, not because of lower levels of productivity. Poor countries have more labor relative to capital, so marginal productivity of labor is greater in rich countries than in poor countries. Nontradables tend to be labor-intensive; therefore, because labor is less expensive in poor countries and is used mostly for nontradables, nontradables are cheaper in poor countries. Wages are high in rich countries, so nontradables are relatively more expensive. [11]

PPP calculations tend to overemphasise the primary sectoral contribution, and underemphasise the industrial and service sectoral contributions to the economy of a nation.

The law of one price, the underlying mechanism behind PPP, is weakened by transport costs and governmental trade restrictions, which make it expensive to move goods between markets located in different countries. Transport costs sever the link between exchange rates and the prices of goods implied by the law of one price. As transport costs increase, the larger the range of exchange rate fluctuations. The same is true for official trade restrictions because the customs fees affect importers' profits in the same way as shipping fees. According to Krugman and Obstfeld, "Either type of trade impediment weakens the basis of PPP by allowing the purchasing power of a given currency to differ more widely from country to country." [11] They cite the example that a dollar in London should purchase the same goods as a dollar in Chicago, which is certainly not the case.

Nontradables are primarily services and the output of the construction industry. Nontradables also lead to deviations in PPP because the prices of nontradables are not linked internationally. The prices are determined by domestic supply and demand, and shifts in those curves lead to changes in the market basket of some goods relative to the foreign price of the same basket. If the prices of nontradables rise, the purchasing power of any given currency will fall in that country. [11]

### Departures from free competition

Linkages between national price levels are also weakened when trade barriers and imperfectly competitive market structures occur together. Pricing to market occurs when a firm sells the same product for different prices in different markets. This is a reflection of inter-country differences in conditions on both the demand side (e.g., virtually no demand for pork in Islamic states) and the supply side (e.g., whether the existing market for a prospective entrant's product features few suppliers or instead is already near-saturated). According to Krugman and Obstfeld, this occurrence of product differentiation and segmented markets results in violations of the law of one price and absolute PPP. Over time, shifts in market structure and demand will occur, which may invalidate relative PPP. [11]

### Differences in price level measurement

Measurement of price levels differ from country to country. Inflation data from different countries are based on different commodity baskets; therefore, exchange rate changes do not offset official measures of inflation differences. Because it makes predictions about price changes rather than price levels, relative PPP is still a useful concept. However, change in the relative prices of basket components can cause relative PPP to fail tests that are based on official price indexes. [11]

## Global poverty line

The global poverty line is a worldwide count of people who live below an international poverty line, referred to as the dollar-a-day line. This line represents an average of the national poverty lines of the world's poorest countries, expressed in international dollars. These national poverty lines are converted to international currency and the global line is converted back to local currency using the PPP exchange rates from the ICP. PPP exchange rates include data from the sales of high end non-poverty related items which skews the value of food items and necessary goods which is 70 percent of poor peoples' consumption. [23] Angus Deaton argues that PPP indices need to be reweighted for use in poverty measurement; they need to be redefined to reflect local poverty measures, not global measures, weighing local food items and excluding luxury items that are not prevalent or are not of equal value in all localities. [24]

## Related Research Articles

Gross domestic product (GDP) is a monetary measure of the market value of all the final goods and services produced in a period of time, often annually. GDP (nominal) per capita does not, however, reflect differences in the cost of living and the inflation rates of the countries; therefore using a basis of GDP per capita at purchasing power parity (PPP) is arguably more useful when comparing differences in living standards between nations.

Per capita income (PCI) or average income measures the average income earned per person in a given area in a specified year. It is calculated by dividing the area's total income by its total population.

In finance, an exchange rate is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in relation to another currency. For example, an interbank exchange rate of 114 Japanese yen to the United States dollar means that ¥114 will be exchanged for each US$1 or that US$1 will be exchanged for each ¥114. In this case it is said that the price of a dollar in relation to yen is ¥114, or equivalently that the price of a yen in relation to dollars is $1/114. The Big Mac Index is published by The Economist as an informal way of measuring the purchasing power parity (PPP) between two currencies and provides a test of the extent to which market exchange rates result in goods costing the same in different countries. It "seeks to make exchange-rate theory a bit more digestible". The Balassa–Samuelson effect, also known as Harrod–Balassa–Samuelson effect, the Ricardo–Viner–Harrod–Balassa–Samuelson–Penn–Bhagwati effect, or productivity biased purchasing power parity (PPP) is the tendency for consumer prices to be systematically higher in more developed countries than in less developed countries. This observation about the systematic differences in consumer prices is called the "Penn effect". The Balassa–Samuelson hypothesis is the proposition that this can be explained by the greater variation in productivity, between developed and less developed countries, in the traded goods' sectors than in the non-tradable sectors. In economics and finance, an index is a statistical measure of changes in a representative group of individual data points. These data may be derived from any number of sources, including company performance, prices, productivity, and employment. Economic indices track economic health from different perspectives. Influential global financial indices such as the Global Dow, and the NASDAQ Composite track the performance of selected large and powerful companies in order to evaluate and predict economic trends. The Dow Jones Industrial Average and the S&P 500 primarily track U.S. markets, though some legacy international companies are included. The consumer price index tracks the variation in prices for different consumer goods and services over time in a constant geographical location, and is integral to calculations used to adjust salaries, bond interest rates, and tax thresholds for inflation. The GDP Deflator Index, or real GDP, measures the level of prices of all new, domestically produced, final goods and services in an economy. Market performance indices include the labour market index/job index and proprietary stock market index investment instruments offered by brokerage houses. The Penn effect is the economic finding that real income ratios between high and low income countries are systematically exaggerated by gross domestic product (GDP) conversion at market exchange rates. It is associated with what became the Penn World Table, and it has been a consistent econometric result since at least the 1950s. The Geary–Khamis dollar, more commonly known as the international dollar, is a hypothetical unit of currency that has the same purchasing power parity that the U.S. dollar had in the United States at a given point in time. It is widely used in economics and financial statistics for various purposes, most notably to determine and compare the purchasing power parity and gross domestic product of various countries and markets. The year 1990 or 2000 is often used as a benchmark year for comparisons that run through time. The unit is often abbreviated e.g. 2000 US dollar or 2000 Int'l$.

Relative purchasing power parity is an economic theory which predicts a relationship between the inflation rates of two countries over a specified period and the movement in the exchange rate between their two currencies over the same period. It is a dynamic version of the absolute purchasing power parity theory.

The Penn World Table (PWT) is a set of national-accounts data developed and maintained by scholars at the University of California, Davis and the Groningen Growth Development Centre of the University of Groningen to measure real GDP across countries and over time. Successive updates have added countries, years (1950-2014), and data on capital, productivity, employment and population. The current version of the database, version 9, thus allows for comparisons of relative GDP per capita, as a measure of standard of living, the productive capacity of economies and their productivity level. Compared to other databases, such as the World Bank's World Development Indicators, the time period covered is larger and there is more data that is useful for comparing productivity across countries and over time.

The International Comparison Program, is a partnership of various statistical administrations of up to 199 countries guided by the World Bank. The main partners of this program are the World Bank, IMF, UN, ADB, OECD, CISSTAT, Eurostat, AfDB ESCWA, ECLAC, DFID, ABS, IDB, NMoFA who are also all part of the executive board.

The KFC Index is an informal guide to measure purchasing power parity comparing exchange rates in African countries. Inspired by the Big Mac Index, the key difference between the two indices is that the KFC Index focuses solely on Africa; the Big Mac Index coverage is worldwide but not as applicable to Africa since McDonald's has little presence there, whereas KFC chains operate in almost 20 countries across the continent.

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