Reasons why Purchasing-power parity is a better metric for comparing people’s well-being than Exchange rates

April 17, 2023 /Economy/ — Purchasing-power parity (PPP) is a measure of the value of different currencies, taking into account the cost of living in different countries. It is often used to compare the standard of living in different countries.

Exchange rates, on the other hand, are the prices of one currency in terms of another. They are determined by supply and demand in the foreign exchange market.

There are a few reasons why PPP is a better metric for comparing people’s well-being than exchange rates.

First, PPP takes into account the cost of living in different countries. This is important because the cost of living can vary significantly from country to country. For example, a gallon of milk might cost $3 in the United States, but it might only cost $1 in India. If we were to compare the standard of living in the United States and India based on exchange rates, we would overestimate the standard of living in the United States.

Second, PPP is more stable than exchange rates. Exchange rates can fluctuate wildly, making it difficult to compare the standard of living in different countries over time.

Third, PPP is more transparent than exchange rates. The calculation of PPP is more transparent than the calculation of exchange rates. This makes it easier to understand how PPP is calculated and to verify its accuracy.

However, there are also a few reasons why exchange rates are important for comparing the economies of different countries.

First, exchange rates determine the prices of goods and services traded between countries. This is important because it affects the competitiveness of different countries’ economies. For example, if the exchange rate between the United States and China is 1:1, then a US company can sell its products in China for the same price as a Chinese company. However, if the exchange rate is 2:1, then the US company will have to sell its products in China for twice the price as a Chinese company. This makes it more difficult for US companies to compete in the Chinese market.

Second, exchange rates affect the flow of capital between countries. This is important because it affects the investment opportunities available in different countries. For example, if the exchange rate between the United States and China is 1:1, then a US investor can invest in Chinese companies for the same price as investing in US companies. However, if the exchange rate is 2:1, then the US investor will get twice as many Chinese shares for the same amount of money. This makes Chinese companies more attractive to US investors.

In conclusion, PPP is a better metric for comparing people’s well-being than exchange rates. However, exchange rates are important for comparing the economies of different countries.

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