Purchasing Power Parity
I wanted to make a quick note of a single sentence that’s helped me in learning how to calculate purchasing power parity between countries, which goes as follows: evaluate consumption of both countries using prices of one country. Using one price lets us normalize the productivity and standard of living across two or more countries.
Take the above chart as an example. Using the purchasing power parity method and U.S. prices, we can calculate Mexican consumption per capita (“per capita” refers to the average consumption level of goods and services per person in the country) in dollars by multiplying the U.S. prices by Mexican consumption:
$1(450) + $3(240) = $450 + $720 = $1,170
We can similarly calculate U.S. consumption per capita in dollars using U.S. prices:
$1(1000) + $3(2,000) = $1,000 + $6,000 = $7,000
We can thus calculate the multiple difference by dividing the U.S. PPP by the Mexican PPP, or $7,000/$1,170 = $5.98. This means that on a normalized scale the average consumer in the U.S. can afford approximately 5.98 times the consumption of the average consumer in Mexico.
The PPP had its big screen moment in China passing the U.S. in PPP but not in nominal terms a while back—this means that Chinese consumers passed the U.S. in terms of purchasing power (e.g., what their money gets them, tying into standard of living), but that the U.S. generates more value at current prices compared to China.
Anyway, that’s all from me! Hope you find it helpful. You can find my economics article collection here.