In our endeavour to enrich the knowledge of our readers we regularly come up with articles giving simple explanantion of economic and financial terms. Next in this series is the Purchasing Power Parity (PPP). Please write to us if you have further queries or you would like us to post explanation of any such term.

What is Purchasing Power Parities (PPP)?

Purchasing power parities (PPPs) are currency exchange rates obtained by comparing the prices of identical goods and services in different countries. These price comparisons are made by dividing the price of a specific good or service in one country by the price of the same item in another country.

For example, if a 300 milliliter can of Pepsi costs Rp16.42 in country A and $3.24 in country B, a price relative can be calculated as 3.24/16.42, or 0.197. This is the “Pepsi PPP” for countries A and B. Also called “price relatives”, PPPs are calculated for several hundred items covering all the final expenditure components of GDP. These PPPs for individual goods and services are then combined to obtain PPPs for higher levels of aggregation such as “Bread and Cereals”, “Food and Beverages”, “Household Individual Consumption” and, eventually, GDP as a whole.

How are PPPs used?

PPPs are used in two ways:

  • First, they are used to convert GDP and its expenditure components to a common currency so that GDP comparisons can be made in real terms. “Real terms” means that differences in price levels between countries have been eliminated so that it is the underlying volumes of goods and services in each country that are compared.
  • Second, PPPs are used to measure differences in price levels among countries. Market exchange rates are currency convertors that include differences in price levels among countries; PPPs are currency convertors that exclude these differences. The ratios of PPPs to exchange rates, therefore, measure the differences in price levels among countries. These ratios are called price level indexes.

Where does India stand in terms of PPP?

As per data compiled by International Monetary Fund (IMF), India ranks fourth in terms of PPP behind only USA, China and Japan. Following is a list of top 15 countries in terms of PPP as compiled by IMF for the year 2009.

Top 15 countries as per PPP (2009)

(Source: IMF)

Adapted from Asian Development Bank (ADB) publications.

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