Editing Purchasing power parity (section)

==Usage==
===Conversion===

Purchasing power parity exchange rate is used when comparing [[Gross domestic product|national production]] and consumption and other places where the prices of non-traded goods are considered important. (Market exchange rates are used for individual goods that are traded). PPP rates are more stable over time and can be used when that attribute is important.

PPP exchange rates help [[costing]] but exclude profits and above all do not consider the different [[Quality (business)|quality of goods]] among countries. The same product, for instance, can have a different level of quality and even safety in different countries, and may be subject to different taxes and transport costs. Since [[market exchange rate]]s fluctuate substantially, when the GDP of one country measured in its own currency is converted to the other country's currency using market exchange rates, one country might be inferred to have higher [[real GDP]] than the other country in one year but lower in the other. Both of these inferences would fail to reflect the reality of their ''relative levels of production''.

If one country's GDP is converted into the other country's currency using PPP exchange rates instead of observed market exchange rates, the false inference will not occur. Essentially GDP measured at PPP controls for the different costs of living and price levels, usually relative to the United States dollar, enabling a more accurate estimate of a nation's level of production.

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The exchange rate reflects transaction values for [[tradable goods|traded goods]] ''between'' countries in contrast to non-traded goods, that is, goods produced for home-country use. Also, currencies are traded for purposes other than trade in goods and services, ''e.g.'', to buy [[capital asset]]s whose prices vary more than those of physical goods. Also, different [[interest rate]]s, [[speculation]], [[Hedge (finance)|hedging]] or interventions by [[central bank]]s can influence the purchasing power parity of a country in the international markets.

The PPP method is used as an alternative to correct for possible statistical bias. The [[Penn World Table]] is a widely cited source of PPP adjustments, and the associated [[Penn effect]] reflects such a [[systematic bias]] in using exchange rates to outputs among countries.

For example, if the value of the [[Mexican peso]] falls by half compared to the [[US dollar]], the Mexican [[gross domestic product]] measured in dollars will also halve. However, this exchange rate results from international trade and financial markets. It does not necessarily mean that Mexicans are poorer by a half; if incomes and prices measured in pesos stay the same, they will be no worse off assuming that imported goods are not essential to the quality of life of individuals.

Measuring income in different countries using PPP exchange rates helps to avoid this problem, as the metrics give an understanding of relative wealth regarding local goods and services at domestic markets. On the other hand, it is poor for measuring the relative cost of goods and services in international markets. The reason is it does not take into account how much US$1 stands for in a respective country. Using the above-mentioned example: in an international market, Mexicans can buy less than Americans after the fall of their currency, though their GDP PPP changed a little.

===Exchange rate prediction===

PPP exchange rates are never valued because market exchange rates tend to move in their general direction, over a period of years.  There is some value to knowing in which direction the exchange rate is more likely to shift over the long run.

In [[Neoclassical economics|neoclassical]] [[economic theory]], the ''purchasing power parity theory'' assumes that the exchange rate between two currencies actually observed in the different international markets is the one that is used in the purchasing power parity comparisons, so that the same amount of goods could actually be purchased in either currency with the same beginning amount of funds. Depending on the particular theory, purchasing power parity is assumed to hold either in the [[long run]] or, more strongly, in the [[short run]]. Theories that invoke purchasing power parity assume that in some circumstances a fall in either currency's purchasing power (a rise in its price level) would lead to a proportional decrease in that currency's valuation on the foreign exchange market.

===Identifying manipulation===

PPP exchange rates are especially useful when official exchange rates are artificially manipulated by governments. Countries with strong government control of the economy sometimes enforce official exchange rates that make their own currency artificially strong. By contrast, the currency's black market exchange rate is artificially weak. In such cases, a PPP exchange rate is likely the most realistic basis for economic comparison. Similarly, when exchange rates deviate significantly from their long term equilibrium due to speculative attacks or carry trade, a PPP exchange rate offers a better alternative for comparison.

In 2011, the [[Big Mac Index]] was used to [[Big Mac Index#Manipulation|identify manipulation of inflation numbers by Argentina]].<ref>{{Cite web|url=https://latitude.blogs.nytimes.com/2011/11/24/argentinas-big-mac-attack/|title=Argentina's Big Mac Attack|last=Politi|first=Daniel|date=2011-11-24|website=Latitude|language=en-US|access-date=2019-10-23|archive-url=https://web.archive.org/web/20191023175605/https://latitude.blogs.nytimes.com/2011/11/24/argentinas-big-mac-attack/|archive-date=2019-10-23|url-status=dead}}</ref>