>>>What is PPP based?<<<
aka “Big Mac Index”
The Big Mac PPP exchange rate between two countries is obtained by dividing the price of a Big Mac in one country (in its currency) by the price of a Big Mac in another country (in its currency). This value is then compared with the actual exchange rate; if it is lower, then the first currency is under-valued (according to PPP theory) compared with the second, and conversely, if it is higher, then the first currency is over-valued.
For example, using figures in July 2008:
1.the price of a Big Mac was $3.57 in the United States (varies by store)
2.the price of a Big Mac was £2.29 in the United Kingdom (Britain) (varies by region)
3.the implied purchasing power parity was $1.56 to £1, that is $3.57/£2.29 = 1.56
4.this compares with an actual exchange rate of $2.00 to £1 at the time
5.(2.00-1.56)/1.56 = 28%
6.the pound was thus overvalued against the dollar by 28%
It means that PPP based GDP for UK = factual GDP minus 28% for this index.
Thanks for the description.
It does not seem like a very accurate method to me. But then, I’m not an economist.
I assume the actual index is calculated using a composite of goods and services, and not on the price of a single commodity. Because there can be considerable variation on the prices of individual items from region to region.