Context:
- India’s share of global consumption at purchasing power parity (PPP) is expected to rise to 16% by 2050, from:
- 4% in 1997
- 9% in 2023
- North America will lead with a slightly higher share of 17% in 2050.
Purchasing Power Parity (PPP)
Definition and Concept
Purchasing Power Parity PPP is a theory that asserts that currencies are in equilibrium if their purchasing power is equal in two different countries.
The theory posits that the value of a currency should be determined by the price ratio of a basket of consumer goods in both nations.
Law of One Price is the foundation of PPP that shows excluding transportation costs similar goods must have the same price in other countries when expressed in a common currency.
PPP Formula
The basic formula of PPP is given by
( S = \frac{P1}{P2} )
Where,
- S Exchange rate between two currencies
- P1 Price of the product in currency 1
- P2 Price of the same product in currency 2
This enables the comparison of the value of currencies by the purchasing power of products in each country.
Versions of PPP
- Absolute PPP: Focuses on the leveling of prices across nations.
- Relative PPP: Focuses on changes in exchange rates due to price differences particularly driven by inflation rates.
Significance of PPP
- Comparison of Purchasing Power PPP enables the comparison of the purchasing power of various currencies, thus making international comparisons more accurate.
- Economic Analysis
- PPP is used to compare the standard of living and productive capacity across nations.
- Adjusting for Price Differences
- Helps normalize comparisons by accounting for price level variations across countries.
International Comparison Program ICP
The ICP managed by the World Bank is an initiative in comparing price levels and computing PPPs for over 170 countries.
- Key objectives
- Generate PPP values and Price Level Indices PLIs
- To generate PPP values and Price Level Indices PLIs to enable crosscountry comparisons of prices.
- Converting GDP
- Converting GDP and spending data into a common currency using PPP to make better comparisons across the countries
- Price Level Indices
- PLIs Measure and compare the relative cost of goods showing variations across regions and time
- Generate PPP values and Price Level Indices PLIs
India Rankings in Global PPP
- India stands as the third-largest economy from the PPP account, contributing considerable expenditure and generating wealth globally.
- Gross Fixed Capital Formation GFCF in India contributes to GDP ranking second in growth in emerging economies in terms of PPP.
- India has a 2083 portion of world GDP based on PPP just behind China 5076.
Challenges and Issues with PPP
- Product Basket Variation
- The PPP exchange rate may change based on the commodities taken into the basket being compared.
- Transport and Tariff Costs
- Import duties and shipping costs may lead to disparity between domestic price and international price.
- Tax Differences
- Different tax rates such as VAT may result in price differences among countries.
- Market Distortions
- Companies may engage in price gouging because of market monopolies or cartels resulting in different PPP values.
