Purchase Power Parity

For anyone who has traveled it’s evident that things do not cost the same in different places, lunch is more expensive in New York than in Bangkok. Therefore it is very different the lifestyle of a person earning $ 1000 a month in Thailand compared to someone who earns the same in the United States. To compensate for these differences when looking at data, economists apply something called conversion factor of Purchasing Power Parity (PPP).

ppp
The same amount of money buys different amounts of products in different places.


In simple terms, the PPP conversion factor is a comparison between the prices of the products of a country (converted to dollars) and its price in the United States.

Say a hamburger costs $ 1 in the United States.

And the same hamburger costs ฿ 12.4 in Thailand.

The exchange rate is $ 1 = ฿ 34.9.

The price of a Thai burger in dollars then is 12.4 / 34.9 = 0.35.

Assuming that the economies of the US and Thailand were only burgers, the PPP factor of Thailand would be 0.35.

Now, which are the cheapest and most expensive countries in the world?


purchasing-power-parity-conversion-factorcountries-by-highest-ppp-cf
countries-by-lowest-ppp-cf

swissFor 2015 the country with the highest conversion factor was Switzerland with prices 32.5% higher than in the United States. At first glance, it gives the impression that the richer a country is the highest it’s conversion factor. This is true to the extent that a higher income brings a higher cost of living. However, a high cost of living does not necessarily mean a higher income.

Island nations like Vanuatu and Tuvalu have a high conversion factor due to being islands, this makes imported products more expensive and production within the country more complicated, however, these countries are not classified as high income.

Countries with inflation problems also tend to have high conversion factors due to the constant increase in prices. An example of this is Zimbabwe, which had an hyperinflationary crisis that peaked in 2008. Its current conversion factor is 0.49. when compared with a similar income country like Uganda whose conversion factor is 0.37, we realize that it’s price level is not a result of its wealth but rather of it’s economic instability.

indibOn the other hand, we have the countries with low conversion factors, India is at the bottom of the list with 0.259, which means that on average the products there are almost four times cheaper than in the United States.

When we compare the quality of life between countries, it’s almost always done by applying this measure. As we said before, it’s very different the lifestyle of a person earning $ 1000 a month in Thailand compared to someone who earns the same in the United States. And the most common indicator where this conversion factor applies is GDP per capita, which we will see in the next article.

Source: World Bank

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