Question

: What is the logic behind the theory of purchasing-power parity?

Answer 1

Solution -

Purchasing-power parity refers to the alternative measures used to compare the GDP of a particular country (gross domestic product or the total value of a year's production of goods and services) with another country.

For example, consider a specific "basket" of goods and services (food, shelter, clothing, leisure, etc.) that a person needs to have a specific "standard of living." Well, an American person visiting China will need to spend far fewer dollars (converted to yuan at current market exchange rates) to earn a living in China than to meet the needs of the United States.For example, compare China's GDP with that of the United States. There are two ways to compare China's GDP in local currency (yuan) and US GDP (US dollars) in local currency. First, we can use the current market exchange rate between the yuan and the dollar to express both GDP in a single currency and then compare them by size (it doesn't matter if you express both in dollars or yuan, the corresponding ratio will be either way).This is the most common way to compare the relative sizes of different economies. However, it is generally the case that at the current market exchange rate, the “cost of survival” in a less developed economy like China will be less than the conversion rate using a dollar earned in US dollars for a visitor to a more developed economy like the US. In yuan at the current market exchange rate.