Purchasing power parity adjustments

What is the law of one price?

An industrial good will be sold everywhere for the same price

What is PPP?

The rate at which the currency of one country would have to be converted into that of another country to buy the same amount of goods and services in country

In order to compare living standards between countries, what is the GDP per head of each country usually?

A common currency- usually the US dollar, at a current market rates

However, this gives an inaccurate indicator of the ability to buy goods and service in different countries as £1 will buy a different in amount of goods in different countries e.g you would need £1.35 to buy a Big Mac in Indonesia but £6.01 in Switzerland

The cost of living is generally higher in developed countries then developing so without some advisement, what does GDP do?

Underestimating living standards in developing countries so ppp allows comparisons between different currencies through a basket of goods approach

What is a basket of goods approach?

Two currencies are in equilibrium or at par when a basket of goods (taking into account the exchange rate) is priced the same in both countries

• PPP is the exchange rate needed to buy the same basket of goods in each country

What does the PPP state in the long run?

Exchange rates move towards the rate that would equalise the prices of an identical basket of goods and services in any two countries

Why are comparisons made using a Big Mac?

There are many different components in a big map that are identical in each country