purchasing power parity
An economic theory stating that exchange rates should adjust so that identical goods cost the same in different countries when expressed in a common currency.
Example
“The Economist's Big Mac Index uses purchasing power parity to compare currency valuations using McDonald's burger prices globally.”
Memory Tip
PPP = the same good should cost the same everywhere (in theory). Used to compare economies fairly.
Why It Matters
Understanding purchasing power parity helps you make informed decisions when traveling or investing internationally. It explains why your money may stretch differently in different countries and guides expectations about fair currency exchange rates over time.
Common Misconception
Many people assume that if a Big Mac costs five dollars in the US and ten dollars in another country, the currency is overvalued by exactly fifty percent. In reality, PPP adjustments account for many factors like local wages, taxes, and transportation costs that affect prices beyond just currency value.
In Practice
If a coffee costs four dollars in New York and the same coffee costs four euros in Paris, PPP suggests the euro-to-dollar exchange rate should make these prices equivalent in a common currency. If the actual exchange rate differs significantly, it suggests one currency may be overvalued or undervalued relative to the PPP prediction.
Etymology
PURCHASING POWER (what money can buy) PARITY (equality, equivalence). Equal PURCHASING POWER across countries.
Common Misspellings
Learn economics & finance from top universities
Related Terms
More in economics
Other economics terms you should know
See Also
Need financial definitions?
Clear definitions for 2,500+ finance, insurance, and investing terms.