Purchasing Power Parity vs Cost of Living

1. Purchasing Power Parity (PPP):

   • PPP is an economic theory that suggests that, in the absence of transportation costs and other trade barriers, identical goods should sell for the same price in different countries when their prices are expressed in a common currency.
   • It is a way to measure the relative value of currencies based on the idea that exchange rates should adjust so that the same basket of goods and services has the same price in different countries when measured in a common currency.
   • PPP is often used to estimate the “fair” exchange rate between two currencies. If a currency’s exchange rate is overvalued according to PPP, it is expected to depreciate, and if it’s undervalued, it’s expected to appreciate.

2. Cost of Living:

   • The cost of living refers to the amount of money needed to maintain a certain standard of living, which includes basic expenses like housing, food, transportation, healthcare, education, and other goods and services.
   • It is highly subjective and can vary significantly from one location to another. Cities or countries with a high cost of living tend to have higher prices for goods and services, making it more expensive to maintain a particular lifestyle.
   • The cost of living can be influenced by various factors, including local economic conditions, supply and demand for specific products and services, government policies, and cultural norms.

Here are some key differences between PPP and the cost of living:

1. Focus:

   • PPP primarily deals with exchange rates and the relative value of currencies. It is used to determine whether a currency is overvalued or undervalued in comparison to another currency.
   • The cost of living focuses on the actual expenses required to maintain a particular lifestyle in a given location. It is more concerned with the daily economic realities for residents.

2. Calculation:

   • PPP involves comparing the prices of a standardized basket of goods and services across different countries.
   • The cost of living is based on the actual prices of specific goods and services in a particular location.

3. Application:

   • PPP is often used in international economics to make exchange rate predictions and assess currency valuations.
   • The cost of living is used by individuals and businesses to budget and plan for expenses in a specific area, such as when deciding on salary adjustments or cost-of-living allowances for employees.