Theory that exchange rates should adjust to equalize the cost of goods in different countries.
Based on information provided by Astrid DeBruyn 2 Purchasing Power Parity
Purchasing PowerHow much your money will buy
Put it all together
Equal value of money
Money should buy the same amount of goods and services in different currencies
3 Purchasing Power Parity
Product / service essentially the same
Product / service is tradable
Free trade in global market
Ignore transportation costs
4 Purchasing Power Parity
Basic digital camera
29.99 in the US
2500 yen in Japan
25 pounds sterling in UK
Where does it cost least Most
5 Purchasing Power Parity
Depends on the exchange rates
Japan cheapest UK most expensive
Yen is undervalued Pound overvalued
Purchasing Power Parity Theory
states that in the long run exchange rates will adjust so that goods will cost the same in every country.
7 Big Mac Index - The Economist magazine - 100 countries - US price of Big Macs 8 The Big Mac index was devised 13 years ago as a light-hearted guide to whether currencies are at their correct level. Our basket is a McDonalds Big Mac which is produced in more than 100 countries. Comparing actual exchange rates with PPPs signals whether a currency is under- or over-valued.The Economist April 1 1999
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