Purchasing Power Parity (PPP)

Definition

A method of comparing economies by adjusting for differences in price levels, so that a given amount of money buys the same basket of goods and services across countries; it converts incomes at a PPP exchange rate rather than the market exchange rate.

Key points

• PPP says that, in the long run, exchange rates should equalise the price of an identical basket of goods between countries (the "law of one price" extended to baskets).
• GDP measured at PPP is generally higher than GDP at market exchange rates for developing economies, because their domestic prices (especially services) are lower.
• On a PPP basis India is among the largest economies in the world, ahead of its rank by market-exchange-rate GDP; verify the latest ranking.
• The PPP data for international comparisons come from the International Comparison Program, coordinated by the World Bank.
• The "Big Mac Index" (by The Economist) is a popular informal illustration of PPP.

Why it matters for CAPF

The idea (price-level adjustment), the result (PPP GDP exceeds market-rate GDP for developing nations), and India's higher PPP rank are commonly tested growth and comparison facts.

Common confusion

PPP GDP differs from nominal (market-exchange-rate) GDP; India ranks higher on PPP than on nominal GDP; PPP is for cross-country comparison, not for actual currency conversion in trade.

Parent note

basics national income and growth