I have some questions regarding what exactly PPP is. In my understanding, PPP is essentially the value that a currency can purchase within an area. For example, although the USA might have more money in the international area, the total amount of monetary value can purchase more goods in China due to the low price of living there.

The problem I have with this is that it seems that value is subjective. For example, it might be cheaper to purchase labor in China than in the US however it is much more costly to purchase an iPhone there. How you decide which is more valuable?

If what I am saying makes no sense at all, please explain what PPP is.


2 Answers 2


What you are describing is basically purchasing power. Purchasing Power Parity (PPP) claims that your purchasing power is the same across countries.

PPP states that, if say a pound of bread costs 4 US$, you can take that amount, exchange it to Chinese yuan, go to China and buy exactly the same amount of bread. (i.e. you have the same purchasing power in both countries)

3 factors play a role: the price (of bread) in the US, the price in China, and the Exchange rate. There is no subjective factor here.

Even though I don't fully understand what you mean by "purchasing labor", make sure that you compare goods, or baskets of goods, only (PPP does not say anything about wages or production costs).

And be sure to remember that PPP does not necessarily have to hold in reality.

Hope this helps!


Based on the official documentation from the World Bank (particularly Chapter 1):

A problem that has challenged economists comparing economies across national boundaries is that the GDP of a country is expressed in its national currency. This requires that national levels of GDP be converted to a common currency before the comparisons can be made. While exchange rates can be used for this conversion, analysts find these to be deficient because of the effect of non-traded goods and services, capital movements, and exchange market interventions. [...] The longstanding recognition of these deficiencies led to the development of Purchasing Power Parities (PPP) as a more appropriate currency converter to compare the GDP and its components across countries.

The definition of PPP:

The Purchasing Power Parity between two countries is the rate at which the currency of one country needs to be converted into that of a second country to represent the same volume of goods and services in both countries.

In more detail:

A Purchasing Power Parity is a form of exchange rate based upon a comparison of prices between countries. The Big Mac Index compiled and published by the Economist is a widely known example of a PPP based on a single consumption item. The Big Mac Index is based on the comparison of its cost between countries compared to its cost in the US. A Big Mac in the Philippines, for example, cost 68 pesos in July 2004 compared to $2.90 in the US. In the Big Mac index, the ratio of the price in pesos divided by the US price is 23.5, and this figure is a basic example of a Purchasing Power Parity between the Philippines and the US. The ratio, 23.5, implies that 23.5 pesos have the same purchasing power as one US dollar.

If one wanted to compare the Philippines economy with the US, the first step would be to convert the level of its GDP to the US dollar. If one were to use exchange rates, the procedure would be to divide the Philippines GDP by 55.3. If the PPP based on the Big Mac Index were used, the GDP of the Philippines would be divided by 23.5 which would nearly double the size of its economy compared to the exchange rate derived level.

Notice that the calculation of PPP is based mostly on market prices (government services are normally based on cost of inputs though). As such, they indirectly incorporate valuation by consumers through the demand for such goods. This is, it could be that prices of e.g. smartphones in China are much lower than in Europe because Chinese consumers value smartphones less (or have less income, another important component of the demand). So valuation of demand is reflected in PPP, through market prices.


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