Purchasing Power Parity and the Big Mac Index - Essay Example

Only on StudentShare

Extract of sample
Purchasing Power Parity and the Big Mac Index

On the other hand, a US Dollar has more purchasing power than a Pakistani or Indian Rupee. These differences are usually because of availability and demand for the goods amongst other factors. By taking an international measure and determining the cost for that measure in each of the two currencies and comparing them we can solve this problem. (McGuigan, 2008)
This formula represents the exchange rate of one currency in relative terms to another currency. P1 is the price of an item in one currency while P2 is the price of the same item in another currency (Investopedia, 2008).
Although according to this theory, the relative prices for a same product should be equal in two different locations. However we rarely see this happen. This theory doesn't even hold true in areas inside a city. For example in a high end posh area of a city might sell the same product at a much higher rate than the shop set up in a low end area.
This brings us to the most popular example of purchasing power parity, the Big Max Index. Calculated by the Economist Magazine, the Big Mac index is used to find the exchange rate to determine the value of other items. Since McDonalds is virtually in every country, this index is readily applicable. ...
Download paper

Summary

When we go at a shop to buy something, we expect to get that product at a value we perceive to be associated with it. Also when we travel abroad, we expect the same product to cost us the same value that we get in the home country. Investopedia defines this phenomenon as the Purchasing Power Parity which in economic terms is a "theory that estimates the amount of adjustment needed on the exchange rate between countries in order for the exchange to be equivalent to each currency's purchasing power."
Author : annabell94

Related Essays

Global Financing and Exchange Rate Mechanisms
The Purchasing Power Parity principle (PPP) was enunciated by a Swedish economist,

Gustav Cassel in 1918. According to this theory, the price levels (and the changes in

these price levels) in different countries determine the exchange rate of these countries

currencies. The basic tenet of this principle is that the exchange rates between various

currencies reflect the purchasing power of these currencies. This tenet is based on the

Law of One Price.
7 pages (1757 words) Essay
Power
These three C's in many ways mirror the three branches of government within the United States: the executive, legislative and judicial branches. Therefore, one may describe the balance of power with the following phrase: "The commission proposes, the Council decides, the Court interprets."
...
12 pages (3012 words) Essay
Freddie Mac, Fannie Mae and Housing Crisis
It allowed for banks charging low mortgage interest rates to encourage anyone interested in buying a home. It led to the creating a secondary market for mortgages. In this market, companies like Fannie Mae borrowed money from foreign markets at minimal interest rates since they were financially supported by the US Government. This enabled Fannie Mae to give fixed rate mortgage that have a very low deposit to any home buyer.
...
9 pages (2259 words) Essay
Purchasing Power Parity"Big Mac Index"
The purchasing power parity or the PPP is also loosely explained as the Big Mac index, as introduced by The Economist in the mid-1980s. In the absolute definition of PPP, the Big Mac, a consumer good sold in practically every part of the world, takes the place of the commodity basket. Using this route gives a more simplistic definition of the theory. Therefore, a Big Mac being sold in the United States must have the same price as Big Mac sold in Australia, for example.
...
4 pages (1004 words) Essay
New Parity concepts to address Globalised economy
Financial institutions, pension funds and institutional investors are reaching out the developing and most prospective markets such as China, India and other Asian markets with lot of investments. In this scenario, there has been a need for proper management of rate fluctuation, risk and exchange rate, which allows the estimation of investment yields and global risk premiums. The important issue is hedging of specific international risks through currency overlay strategies, derivatives and credit risk management models.
...
3 pages (753 words) Essay
Purchasing Habits
The next stage determining the consumers buying behaviour is the actual situation of the consumer which either puts him/her in a position to acquire certain products which are dependent on social, economical or technical positions. Factors under this group include the following factors. (Kennedy 2007)
...
8 pages (2008 words) Essay
purchasing power parity
bsolute purchasing power parity to distinguish it from a related theory relative purchasing power parity, which predicts the relationship between the two countries relative inflation rates and the change in the exchange rate of their currencies (Wikipedia, 2006).
...
7 pages (1757 words) Essay
Got a tricky question? Receive an answer from students like you! Try us!