PPP Calculator (Purchasing Power Parity)

The purchasing power parity (PPP) compares what a given currency can actually buy in different countries. While the exchange rate tells us that $100,000 is worth about €80,000, for example, it doesn't tell us whether you would have the same standard of living with $100,000 in the US as you would with €80,000 in France. The PPP closes this gap.

This calculation tool has three applications. It can convert salaries from one country to another to ensure a consistent standard of living; it can convert the prices of two identical products to determine an implied exchange rate and whether a currency is over- or undervalued; and it can predict how the exchange rate should change over time if inflation rates in two countries are different.

What purchasing power parity means:

If the cost of a basket of goods is equal in both countries when converted using the exchange rate, then the two currencies are said to be at purchasing power parity. This concept is based on the law of one price: the same product should have the same price everywhere. Otherwise traders would buy it where it was cheaper and sell it where it was more expensive until prices converged.

But the reality of economics doesn't always meet this ideal state. Rent, haircuts and bus tickets are not tradable across borders; taxes and tariffs present obstacles; and wages vary from country to country. So the PRC should be understood as a long-term anchor and benchmark, rather than a prediction of tomorrow's exchange rate.

Absolute purchasing power parity and implied exchange rate.

In absolute terms, purchasing power parity (PPP) is the exchange rate between two currencies that should be equal to the ratio of their price levels. If a product costs P1 in one currency and P2 in another currency, then the implied PPP exchange rate can be expressed as follows:

Suppose a hamburger costs $5 in the US and 10 units of foreign currency abroad. The implied exchange rate is the amount of foreign currency per dollar, calculated as 10 divided by 5, or 2 units of foreign currency per dollar. If the market exchange rate is 2.5 units of foreign currency per dollar, then this price level indicates that the market values the foreign currency lower and it is undervalued. The "Big Mac Index" popularizes these comparisons by using the same price for a single sandwich in different locations around the world.

The difference in valuation that this calculator shows is calculated by dividing the implied exchange rate by the market exchange rate and then subtracting 1. A negative number indicates that currency 2 is undervalued while a positive number indicates it is overvalued.

Salary comparison with the help of the PPP

To compare salaries across different countries, the respective PPP factors for each country must be known. These are values that indicate how many units of local currency would be required to purchase the same thing that could be purchased with one International Dollar (ID) in the US. The World Bank publishes these data under the code PA.NUS.PPP. The corresponding salary is then calculated by the following formula:

F is the PPP factor for each country. As this factor is based on the US, the factor for the US is 1. Suppose you earn $50,000 in a country and that country's PPP factor is 1, and you want to know what salary would be required to maintain the same standard of living in another country with a PPP factor of 20. The result is the salary in the target currency, calculated as 50,000 multiplied by 20 and divided by 1, which is $1,000,000.

Below are some rough PPP conversion factors for various economic areas. These are only to give a sense of the distribution of data; please check with the World Bank for current values for your country before making decisions based on specific numbers.

Relative PPP and inflation differentials

The relative PPP focuses on changes rather than absolute levels. The currency of a country with high inflation tends to depreciate over time, by an amount roughly equal to the difference in the two countries' inflation rates. The forecasted exchange rates after several years are as follows:

S0 is the current exchange rate expressed in terms of domestic currency, i.e., how many units of domestic currency are required to buy one unit of foreign currency. The two i-terms represent annual inflation rates and t represents the number of years. If the domestic inflation rate is 5%, the foreign inflation rate is 2% and the current exchange rate is 1.10, then in five years' time the exchange rate will be approximately 1.27. This is because prices rise faster domestically than abroad, which leads to a depreciation of the domestic currency.

Applications of the PPP

Job seekers considering a job overseas can use the PPP to assess whether a higher nominal wage actually leads to a higher standard of living. Remote workers and employers can use it to set fair cross-border pay rates. Economists use the PPP instead of market exchange rates to measure the true size of an economy, as market exchange rates tend to undervalue large economies with lower prices. Investors look for valuation differences and assess whether a currency is deviating strongly from its fundamental values.

Restrictions to note:

The PPI compares baskets of goods but the basket of goods in each country is not identical. The weighting of housing, healthcare and local services varies from country to country. Trade barriers, transportation costs and taxes create price differences. While a single index like the Big Mac Index is intuitive and easy to understand, its scope is limited. The PPI is not meant to predict daily exchange rates but should be considered as a more reliable long-term benchmark.

This calculator is for educational and planning purposes only and does not constitute financial or immigration advice. As the PPP factors and inflation rates change, please check current data from official sources before making decisions.