Purchasing power parity

Purchasing power parity (PPP) is a theory that tries to work out how over- or undervalued one currency is in relation to another.

Purchasing power parity (PPP) is a theory that tries to work out how over- or undervalued one currency is in relation to another. It does this by comparing the price of two identical goods in different economies.

Say, for example, a Mars bar costs 70p in Britain and the identical product costs $1 in America. The theory suggests that the exchange rate between sterling and the US dollar should be about 1.43 i.e, £1 buys you about $1.43 (since 70p x 1.43 is roughly 100c, or $1).

So if, in fact, the exchange rate is, say, 1.60, then sterling is overvalued relative to the US dollar. It suggests that either sterling will weaken or the dollar should strengthen.

The problem with using PPP this way is that it makes quite a few assumptions, mainly that the input costs (raw materials, labour and so on) are equal for something like a Mars bar, no matter where it is sold.

Most Popular

Fan heater vs oil heater – which is cheaper?
Personal finance

Fan heater vs oil heater – which is cheaper?

Sales of portable heaters have soared, as households look to cut their energy costs. But which is better: a fan heater or an oil heater? We put them t…
21 Nov 2022
Best regular savings accounts – December 2022
Savings

Best regular savings accounts – December 2022

You can earn an attractive rate on the best regular savings accounts. We tell you the best on the market to take advantage of right now
1 Dec 2022
Wood-burning stove vs central heating ‒ which is cheapest?
Personal finance

Wood-burning stove vs central heating ‒ which is cheapest?

Demand for wood-burning stoves has surged as households try to reduce their heating costs this winter. But how does a wood burner compare with central…
29 Nov 2022