Define: Purchasing Power Parity

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Definition: Purchasing Power Parity



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Full Definition of Purchasing Power Parity


Purchasing power parity calculates exchange rates in terms of how much goods a currency can buy. Here’s how purchasing power parity works: Imagine two countries, Alphastan and Betastan, produce only widgets. A widget costs 1 alpha in Alphastan and 3 betas in Betastan. The current exchange rate is 1 alpha = 6 betas. Under purchasing power parity, the alpha is overvalued vis-à-vis the beta, because each alpha buys goods worth only 3 betas. Alphastanians conscious of purchasing power parity would rush to Betastan, get six betas for an alpha, buy two widgets (6 beta/3 beta per widget) per alpha, and rush home. Purchasing power parity would thus anticipate that the people in Alphastan would bid up the beta until an alpha bought only 3 beta. Since purchasing power parity computations require that the goods be the same in every country, the Economist magazine uses a McDonald’s hamburger for its world index of purchasing power parity. While more sophisticated analyses use a bundle of goods to compute purchasing power parity, determining purchasing power parity for complex economies remains difficult.


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Definition Sources


Definitions for Purchasing Power Parity are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 6th February, 2020