Purchasing power parity

A purchasing power parity is a conversion rate based on the relative prices of goods and services in two or more economies. In a simple illustration, if a comparable basket costs 100 units of one currency and 50 units of another, the basket-based parity is two units of the first currency for each unit of the second. Actual international comparisons use broad, carefully defined sets of items rather than one product. The idea is to express economic quantities in a common unit while accounting for differences in local price levels.

Large-scale comparisons collect prices for specified goods and services in participating economies and combine them with national-accounts expenditure data. In the World Bank's International Comparison Program, the priced items are selected to be comparable across economies and to represent important purchases; expenditure categories help weight and aggregate the resulting price comparisons. PPPs can be calculated for categories of expenditure and combined into measures for gross domestic product (GDP). Because products, spending patterns and prices differ across places, compiling a robust comparison requires extensive data collection and statistical validation.

PPPs are used to convert GDP and related expenditure measures into a common unit for comparing the real volume of economic activity across countries. They also inform comparisons of GDP per person and price levels. A market exchange rate is set in foreign-exchange markets and is useful for many cross-border financial flows, but it does not by itself adjust for the cost of locally purchased goods and services. For analyses of domestic output or purchasing power, PPP-based comparisons can therefore give a different picture from one converted at market rates. Which measure is appropriate depends on the question being asked.

A PPP estimate is not a quoted currency rate, a forecast of exchange-rate movements or a guarantee that a particular person can buy the same basket. It summarizes prices for a defined comparison and reference period; it does not show how income is distributed within a country or capture every household's spending pattern. International price comparisons are demanding to produce, and broad baskets and national expenditure data must be made sufficiently comparable. When new surveys are not available for every period, later estimates may require extrapolation. PPP-adjusted GDP per person is consequently a useful comparison of average economic quantities, not a complete measure of individual welfare or living conditions.