Purchasing Power Parity Formula

Purchasing Power Parity Formula (Table of Contents)

Purchasing Power Parity Formula
Examples of Purchasing Power Parity Formula (With Excel Template)
Purchasing Power Parity Formula Calculator

Purchasing power parity is an economic indicator used to calculate the exchange rate between different countries for the purpose of exchanging goods and services of the same amount.

So the formula of Purchasing Power Parity can be defined as :

S = P1 / P2

Where,

S = Exchange Rate
P1 = Cost of goods in Currency 1
P2 = Cost of goods in Currency 2

Examples of Purchasing Power Parity Formula (With Excel Template)

Let’s take an example to understand the calculation of Purchasing Power Parity in a better manner.

For example – Let’s take an example of US dollar equal to 60 in Indian rupees ( 1$ = 60). American visited India for the first time and he purchases 10 cupcakes for Rs 120 and says cupcake are cheaper here, in the US he buy a similar cupcake for $3. So here $3 = 180, which means 15 cupcakes in India so the PPP ratio for the exchange of cupcake is $3 = 120, that is $1 = 40.

Example #1

Burger King offers king paneer burger in India for Rs 109 and in the US it offers for the same burger for $4, So from the above information, we have to calculate exchange rate that is purchasing power parity.

Solution:

P1 = 109
P2= $4 (1$=50) = 4*50 = 200

Purchasing Power Parity is calculated using the formula given below

S = P1 / P2

Purchasing Power Parity = 109/200
Purchasing Power Parity = 0.545

So purchasing power parity between India and US is 0.545 for paneer king burger.

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From the above example, we can understand that the exchange rate between the dollar and Indian rupee we can say that the dollar is overvalued as compare to Indian currency and vice versa.

Example #2

Company ABC having its business of fast food in US and Britain. So they sold pizza and all the other food. In the US they sell one pizza of $8 and in Britain, they sold the same pizza for 4 pounds so from above information calculate the purchasing power parity with the help of the exchange rate.

Solution:

P1 = $8
P2 = 4 £

Purchasing Power Parity is calculated using the formula given below

S = P1 / P2

Purchasing Power Parity = 8 / 4
Purchasing Power Parity = 2

So here the exchange rate between the US and Britain is 2. So from the above example, we can say that US Currency is overvalued than Britain and if the opposite the situation then there may be chances that opposite the things.

Example #3

Company A is producing rice and wheat and exporting all over countries. In India, the selling rate for wheat is 1 quintal = 4000 Rs and Rice is 1 quintal = 5000. And in US same wheat and rice selling rate is 8000 and 9000 per quintal respectively. So calculate purchasing power parity.

Solution:

For Wheat

First, we will calculate for wheat

Purchasing Power Parity is calculated using the formula given below

S = P1 / P2

Purchasing Power Parity = 4000 / 8000
Purchasing Power Parity = 0.5

For Rice

Secondly, we will calculate for Rice

Purchasing Power Parity is calculated using the formula given below

S = P1 / P2

Purchasing Power Parity = 5000 / 9000
Purchasing Power Parity = 0.556

You can download this Purchasing Power Parity Formula Excel Template here – Purchasing Power Parity Formula Excel Template

Explanation

In the purchasing power parity formula, we concentrate on calculating the exchange rate between different countries. Purchasing power parity used for making an adjustment in exchange rates of two different currencies to make them at par with the purchasing power of each other. In other word expenditure on commodity should be same in both the currencies when it accounted for the exchange rate.

Purchasing power parity used to compare the income level in different countries. Thus PPP makes it easy to understand and interpret data of each country.

Purchasing power parity includes calculating the exchange rate between different countries for exchanging goods. Purchasing power parity used for calculating exchange so we can buy the same amount of goods and services in every country.

S = P1 / P2

So in the formula, P1 is the price of goods in one currency and P2 is the price of goods in another currency and S is the exchange rate which is used to buy the goods and services in other countries with the same amount of money.

Relevance and Use of Purchasing Power Parity Formula

Purchasing power parity having more important from the point of view of the world economy. PPP having more relevance and importance from the point of view of the economy. For the exchange of goods and services from different countries. PPP helps to exchange the goods and services of the same amount with the same amount of expenses.

Different countries having a different standard of living and cost of living, so in this type, PPP helps us to understand the economy and exchange the goods and services. And also help us to compare the output within the different countries. So PPP is the economic indicator to calculate the exchange rate.