Purchasing Power Parity - PPP

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DEFINITION of 'Purchasing Power Parity - PPP'

An economic theory that estimates the amount of adjustment needed on the exchange rate between countries in order for the exchange to be equivalent to each currency's purchasing power.

The relative version of PPP is calculated as:

 

Purchasing Power Parity (PPP)

Where:
"S" represents exchange rate of currency 1 to currency 2
"P1" represents the cost of good "x" in currency 1
"P2" represents the cost of good "x" in currency 2

BREAKING DOWN 'Purchasing Power Parity - PPP'

In other words, the exchange rate adjusts so that an identical good in two different countries has the same price when expressed in the same currency.

For example, a chocolate bar that sells for C$1.50 in a Canadian city should cost US$1.00 in a U.S. city when the exchange rate between Canada and the U.S. is 1.50 USD/CDN. (Both chocolate bars cost US$1.00.)

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