To compute purchasing power parity
To compute purchasing power parity (PPP), follow these steps:
1. Select a basket of goods and services that are commonly consumed in both countries being compared.
2. Determine the prices of the selected basket of goods and services in each country's currency.
3. Convert the prices of the selected basket of goods and services in each country's currency into a common currency using the current exchange rate.
4. Compare the prices of the selected basket of goods and services between the two countries to calculate the relative cost of living.
5. Calculate the exchange rate adjustment that would make the relative cost of living equal between the two countries. This is the PPP exchange rate.
For example, if the relative cost of living is higher in Country A compared to Country B, the PPP exchange rate would be lower for Country A's currency compared to Country B's currency.
It is important to note that purchasing power parity is an economic theory that suggests that in the long run, exchange rates should adjust to equalize the purchasing power of different currencies. In reality, exchange rates are determined by various factors including market forces and government policies.