Monday, January 26, 2015

Purchasing Power Parity

One of the main themes of our course is understanding differences between nations.  In order to do this we need to measure stuff (income, education, health, etc.) that we want to compare.   One of the issues with comparing income measures (like GDP, GNP and GNI) across nations is that when converting to a common currency (for apples-to-apples comparisons) if we rely on official ("market") exchange rates, we may underestimate living standards in developing nations due to lower prices of "non-traded goods".   For accurate comparisons of living standards, we should convert a nation's income to another currency value using the Purchasing Power Parity exchange rate, rather than the official exchange rate.

Here is a link to FAQ about PPP at OECD.

Here is more reading about PPP vs. official exchange rates at IMF.

Here is a link to a recent article at The Economist describing the Big Mac index, which was designed to be a cute and easy way to understand the idea of purchasing power parity exchange rates.