Sign Up Now
Get instant access to over 1 million+ study documents
OR
Already registered? click here to login
By creating your account, you agree to our terms of service, privacy policy and student honor code.
).
Basket of Goods the PPP exchange rate calculations are also controversial because of the difficulties involved in finding comparable 'baskets of goods' to compare purchasing power across countries. People in different countries typically consume different baskets of goods; assign varying priorities to different goods; and even the goods available for purchase may differ across countries. Moreover, what is considered a luxury in one culture could be considered a necessity in another. The PPP exchange rate would consequently vary greatly depending on the choice of goods used for the index and makes it vulnerable to errors due to a deliberate or accidental bias in calculations by the choice of a differing bundle.
Quality of Goods: While comparing the prices of goods in different countries for the purpose of calculating PPP, the quality of goods is not taken into account. For instance, a hat is considered to be just a hat although the value of a shoddily made hat would be considerably lower than that of a well made high quality hat.
Measuring Poverty with PPP International monetary agencies such as the World Bank and the IMF frequently use the purchasing power parity to measure global poverty. The approach has been severely criticized in a Columbia University Study in 2005 titled "How Not to Count the Poor." The study argues that employing "a concept of purchasing power 'equivalence' that is neither well defined nor appropriate for poverty assessment" has led the World Bank to "understate the extent of global income poverty and to infer without adequate justification that global income poverty has steeply declined in the recent period" (Reddy and Pogge, 2005)
Conclusion
The purchasing power parity (PPP) theory is a useful economic concept that helps economists to compare the 'real' purchasing power of people in different countries by equalizing their GDP on the basis...
It can also sometimes help us to evaluate whether the currency of a particular is under or over valued. The theory should, however, be used with caution as it has its limitations mainly due to the fact that the conditions required for PPP such as the absence of trade barriers and transportation costs and tradability of all goods do not exist in the real world.
References
Neary, J.P. (2004). "Purchasing Power Parity." Prepared for Encyclopedia of World Trade Since 1450, ed. J.J. McCusker et al., New York: Macmillan Reference. Retrieved on February 29, 2008 at http://www.ucd.ie/economics/staff/pneary/pdf/ppp.pdf
Purchasing Power Parity" (n.d.) the University of British Columbia. Retrieved on February 29, 2008 at http://fx.sauder.ubc.ca/PPP.html
Purchasing Power Parities (PPP): Frequently Asked Questions." (2007). OECD: Statistics Directorate. Retrieved on February 29, 2008 at http://www.oecd.org/faq/0,3433,en_2649_34357_1799281_1_1_1_1,00.html
Reddy, S.G. And Pogge, T.W (2005). "How not to Count the Poor." Columbia University. Retrieved on February 29, 2008 at http://www.columbia.edu/~sr793/count.pdf
Suranovic, S.M. (2006). "International Finance Theory and Policy." Chapter 30: Introduction to Purchasing Power Parity. Retrieved on February 29, 2008 at http://internationalecon.com/Finance/Fch30/F30-1.php
purchasing power parity (PPP) states that the exchange rate between two currencies is related to the relative prices in the two countries so that exchange rate-adjusted prices will be equal between the two countries (Norrbin, and Conover). (Dryden, Reut, and Slater) further stated that, as purchasing power parities (PPP's) are nothing more than interspatial price indexes (by analogy with the inter-temporal price indexes such as consumer price indexes), the methodology,
International Finance Purchasing Power Parity Purchasing Power Parity (PPP), also known as the law of one price, operates under the assumption that product prices in one country translate into an equal price in another country. The price similarity assumption is used to gauge currency exchange rate pressures. If the law of one price is assumed, then the premise establishes that the relational value of currencies must converge to equilibrium. The equation expresses
If the average person has two sets of clothes in one society and thirty in another, then the parity of price of clothes is hard to assess. It certainly cannot be assessed in terms of the cost alone or the number of outfits that a person "should" have (Taylor & Taylor, 2004). It might be set at the percentage of annual wages that a person spends on clothing, but
Global Imbalances in Trade and Purchasing Price Parity: Evidence From Research and Current Trends The recent global economic collapse threw into sharp relief the degree to which the world's economies are inextricably linked and co-dependent. A failure in one major economy will automatically and almost instantly have a negative effect on the other major economies of the world, and these effects trickle down in a substantial stream to all but the
The measurement error may come from any number of omitted variables. Researchers also found that when the dependent variable is relative exports, productivity shows slightly better results than unit labor costs, but the reverse is the case when the dependent variable is bilateral trade balances. In other words, the authors discovered 'fairly strong [empirical] support" for the Ricardian model despite the intense difficulties in structuring international comparisons between productivity and labor
Big Mac Index is contstructed upon the theory of purchasing-power parity (PPP) where it is postulated that a dollar should buy roughly the same amount in all countries. Theoretically the exchange rate over time between two countries should move towards parity that will equalize the prices identical basket of goods and services in each country indexed. The "basket" that the Economist chose is the McDonald's Big Mac. This product is