Purchasing power parities (PPPs) - calculation and uses
Purchasing power parities (PPPs) are indicators of price level differences across countries. PPPs tell us how many currency units a given quantity of goods and services costs in different countries. PPPs can thus be used as currency conversion rates to convert expenditures expressed in national currencies into an artificial common currency (the purchasing power standard (PPS), eliminating the effect of price level differences across countries.
PPPs make it possible to produce meaningful volume or price level indicators required for cross-country comparisons, truly reflecting the differences in the purchasing power, for example, of households. Monetary exchange rates cannot be used to compare the volumes of income or expenditure because they usually reflect more elements than just price differences (e.g. volumes of financial transactions between currencies, expectations in the foreign exchange markets).
Purchasing power parities are obtained by comparing price levels for a basket of comparable goods and services that are selected to be representative of consumption patterns in the various countries.
PPPs are, at the lowest level, bilateral price relatives between tightly defined individual items (e.g. one loaf of bread in the United Kingdom, GBP 1.50, to EUR 2.00 in Germany). Subsequently, these relatives are turned into multilateral relatives and scaled to the European Union (EU) average and aggregated to more and more complex aggregates (e.g. food) and finally to the whole gross domestic product (GDP). PPPs are aggregated price ratios calculated from price comparisons over a large number of goods and services.
Use of PPPs
PPPs are employed as either:
- currency converters to generate volume measures with which to compare levels of economic performance, total consumption, investment, overall productivity and selected private household expenditures;
- price measures with which to compare relative price levels, price convergence and competitiveness.
Eurostat produces three sets of data using PPPs:
- levels and indices of real final expenditure – these are measures of volume; they indicate the relative magnitudes of the product groups or aggregates being compared; at the level of GDP, they are used to compare the economic size of countries;
- levels and indices of real final expenditure per head – these are standardised measures of volume; they indicate the relative levels of the product groups or aggregates being compared after adjusting for differences in the size of populations between countries; at the level of GDP, they are often used to compare the economic well-being of populations;
- comparative price levels – these are the ratios of PPPs to exchange rates; these indices provide a comparison of the countries’ price levels with respect to the EU average – if the price level index is higher than 100, the country concerned is relatively expensive compared with the EU average and vice versa; at the level of GDP, they provide a measure of the differences in the general price levels of countries.