Purchasing Power Parity

Purchasing Power Parity PPP

Purchasing Power Parity PPP When you want to know the strength of a country’s economy and its ranking among the countries of the world in terms of the strength of the economy, the first thing you will do is to search for the value of the GDP of that country. Through GDP, you can see how strong a country’s economy is, because it measures the total of products and services produced within each country. When you look for a country’s GDP in an economic data location, you will always find two different GDP values: nominal GDP (usually used) and PPP GDP, usually symbolized by the PPP symbol. In the next Binary Option Club article you will learn about PPP and how it is used to extract and compare economic data.

According to the Economist, published by The Economist, the purchasing power parity theory states that the exchange rate between two countries is in equilibrium when purchasing power within the two countries is equal at the same exchange rate. The theory is based on the idea that the method of measuring the size of countries’ economies by comparing the nominal GDP of each country does not give a real picture of the real strength of each economy because the purchasing power and the cost of living within each country are not taken into consideration.

Purchasing Power Parity
Purchasing Power Parity

PPP theory provides a way to compare countries’ economies by taking into consideration the purchasing power of the currency within any country, and therefore not taking into account the exchange rate between currencies but the cost of living calculated through a basket of products and services.

The size of the economy is usually compared to two countries by comparing the two countries by their exchange rate (or convert them into a single currency) in the foreign currency market known as Forex. In contrast, purchasing power parity theory depends on purchasing power by basket of products and services in comparison Among the economies of countries.

The theory is based on the concept of purchasing power, which is the ability of citizens within a country to acquire their goods and services through the individual income they receive, because purchasing power may vary in these countries, although per capita income may be equal.

For example, assuming China’s per capita income is equivalent to 6,921 yuan, or $ 1,000 per exchange rate, the average per capita income in the United States is $ 10,000. With the figures mentioned, you can easily say that the average income in the US is 10 times the average per capita income in China, so the US economy is ten times bigger than the Chinese economy. Which does not accurately reflect the strength of the two economies because it does not take into account the cost of living and the purchasing power of citizens within each country, in addition to the exchange rate of the Chinese currency in the market does not reflect the real value of the intervention of the Central Bank of China to permanently devalue against other currencies to increase the competitiveness Exports of Chinese companies.

This assumption would be correct if the cost of living is equal between the two countries, meaning that the purchasing power of Chinese citizens is equal to the purchasing power of citizens in the United States. Suppose, for example, that the average price of goods and services in China is equivalent to 1/3 (0.33) average prices of goods and services in the United States, meaning that a Chinese citizen can obtain twice the goods and Binary Option Club Review services three times than the American citizen will receive the same amount. In other words, a Chinese citizen can earn US $ 100 twice as much as three times the US citizen’s goods and services.

Hence, only the purchasing power parity theory, the average per capita income in the United States is not 10 times the average per capita income, but only 3 times. If we assume that a commodity in the United States is priced at $ 30, and in China the price of the same commodity is only $ 10, it means that the purchasing power parity between China and the United States is 10/30 = 33.33%, meaning that China’s citizen spends 33.33% Is spent by the American citizen, while the citizen spends in the United States 300% of what the citizen spends in China to obtain the same commodity.

PPP theory compares countries’ economies by taking into account the standard of living in each country by calculating the cost of living and the general price level. The advantage of this theory is its representation of economic data to measure the true strength of average per capita income and the economy in general, while reducing the importance of the value of currencies and their prices in the exchange markets, since the latter does not reflect the real value of the currency as a result of government intervention in determining their PPP value or Known markets.

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