Purchasing power parity

Die Kaufkraftparität vergleicht die Purchasing power zwischen zwei unterschiedlichen Standorten. Das kann sowohl innerhalb eines gleichen Währungsgebietes sein, als auch zwischen unterschiedlichen Währungsräumen. Sie liegt vor, wenn zwei identische Warenkörbe an beiden Standorten zum gleichen Geldwert erworben werden können.

Method of determining purchasing power parity

For comparison, a shopping basket is created from defined goods and services that represent the typical cost of living.

The sum of money is calculated and compared for both locations. If the amounts are the same, there is purchasing power parity. In the case of different currency areas, the sums of money determined in the two shopping baskets are made comparable using an exchange rate. If purchasing power parity is present, the nominal and real exchange rates are identical.

Theory of purchasing power parity

The starting point is the thesis that a certain monetary unit must have the same purchasing power in every country in the world. But that also means that the same product would have to be sold all over the world for the same price. Otherwise, contracts for difference would be possible, the so-called arbitrage deals.

From this it is deduced that exchange rate fluctuations between two currencies serve to compensate for price differences in order to ensure the said theory. The basis of the consideration of the purchasing power parity theory is the comparison on the basis of a US dollar. It is determined how many units of another currency have to be used for the identical shopping cart.

The value is called relative purchasing power parity. The exchange rate may leave this value with short-term fluctuations, but in the long term the theory says it must move around this value.

The theory is not undisputed. In particular, this simplified representation neglects that the development of exchange rates is subject to a further series of influences that pursue completely different goals. Exchange rates are also objects of speculation. The share of foreign exchange transactions from buying and selling goods is insignificant in foreign exchange trading.

An exemplary example is George Soros' speculation in 1992 against the British pound. With speculative foreign exchange trading alone, he brought the currency to collapse and realized billions with his bet on falling exchange rates.

Example of purchasing power parity

The exchange rate between the US dollar and any currency is 1.50 units. This means that in order to acquire one US dollar, 1.50 units of the sample currency must be spent.

However, the purchasing power parity between the US dollar and the sample currency is 2.00 units. This means that in the example country, the same amount of goods could be bought with 2.00 units of the currency as in the USA with 1.00 US dollars.

  • Goods ABC for $ 1.00
  • Goods ABC for 2.00 units of the sample currency
  • 1.50 units of the example currency = $ 1.00
  • = Goods ABC would have to cost 1.50 units of the sample currency

That means the sample currency is overvalued. The difference between the exchange rate on the stock exchange and the higher purchasing power parity is scope for a difference business. Dollars are bought at a rate of 1.50; these dollars are used to purchase goods in the USA that can be sold at a profit in the sample country. The prices in the sample country are too high (adjusted for the exchange rate).

Summary

  • purchasing power parity compares purchasing power between two locations
  • A comparison is based on identical shopping carts and services
  • assuming purchasing power parity, adjusted for the exchange rate, the same goods have the same prices
  • the correction of exchange rates through commodity transactions according to the theory of masticatory power is controversial
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