PPS: how currencies determine the purchasing power of people

Have you ever wondered why the same thing costs differently in different countries? The answer lies in the concept of purchasing power parity (PPP) — a tool that helps economists and traders understand the real value of money.

PPP is a method of comparing currencies by analyzing the cost of goods and services in different regions. For example, if the same product costs $10 in the USA and 1000 rubles in Russia, then PPP is a tool that allows you to determine which currency has greater real purchasing power.

How the PPS Principle Works

The basis of the PPP lies in the so-called law of one price. The theory suggests that without barriers, identical goods would cost the same everywhere ( taking into account exchange rates ).

Imagine: a smartphone in the USA costs $500, while in Japan it costs 55,000 yen. According to purchasing power parity, the exchange rate should be about 110 yen per dollar. Makes sense?

In practice, everything is much more complicated. Taxes, logistics, demand in the local market—all of this affects the final price. Therefore, economists analyze not individual goods but a whole basket of goods: food, housing, clothing, energy. By comparing this basket in different countries, one can determine the relative strength of currencies.

Why is PPS needed in the real economy

PPS is not just an academic indicator — it is a tool for adjusting a country's GDP. The gross domestic product calculated at the current exchange rate can give a distorted picture of the population's well-being.

Let's take India. Its GDP per capita appears low when calculated in the usual way. But if we apply the PPP adjustment and take into account the actual cost of living, the picture changes. The average income becomes more comparable to developed countries.

The International Monetary Fund and the World Bank use the GDP adjusted for PPP to analyze the global distribution of income.

Comparison of the standard of living in different regions

50,000 dollars a year can be a decent income in one country and barely a subsistence level in another. PPP is a tool that shows the true difference.

Prediction of long-term currency trends

Exchange rates fluctuate due to policies, financial markets, and speculations. However, in the long term, they tend to approach the level of PPP. Analysts use this indicator to forecast currency movements over a horizon of several years.

Identifying currency manipulation

Some governments artificially inflate or deflate the official exchange rate. PPP allows for the identification of such manipulations and provides objective data on the real value of currency.

Classic example: Big Mac index

The publication The Economist suggested a fun and illustrative way to demonstrate PPP. Since the Big Mac from McDonald's is standardized worldwide, its price serves as a quick indicator of purchasing power.

If a Big Mac costs $5 in the USA and $3 in India, it indicates a difference in the cost of living and currency strength. Later, similar indexes appeared: iPad, KFC, and other standard goods.

Weaknesses of PPS

Despite its usefulness, this method has limitations:

The quality of goods varies. The same product may be more expensive because it is indeed of better quality. A simple price comparison is not always objective.

Non-tradable goods. Real estate, hairdressing services, electricity — they are not sold on the international market. Their prices depend solely on local conditions.

Inflation changes calculations. PPP assumes relative price stability, but inflation can significantly distort the picture. Data that is relevant today may become outdated in a few months.

PPS and cryptocurrency markets

Although the PPS and cryptocurrency markets are not directly related, this indicator helps to understand how people in different countries perceive digital assets.

Bitcoin and other cryptocurrencies are global assets available everywhere. However, in countries with weak currencies (according to PPP), they become more expensive in the local currency, turning into a hedging tool against devaluation.

This is especially relevant for countries facing hyperinflation. In such regions, stablecoins offer people a real way to preserve purchasing power. PPP helps determine whether converting the local currency into a stablecoin is beneficial in a specific country.

Traders and investors can use PPS to analyze the demand for cryptocurrencies in different regions — this provides insight into where cryptocurrencies may gain the most adoption.

Results

Purchasing power parity is a powerful tool for understanding the global economy, income levels, and the real value of money. Despite its limitations, PPP is a way to objectively compare the economic indicators of different countries.

For those who monitor the cryptocurrency markets, it is worth remembering: the PPS shows where people are most interested in protecting their purchasing power through digital assets. And this is already food for thought.