Purchasing power parity measures currencies' comparative abilities to purchase goods and services. For example, if a haircut costs 140 baht in Thailand but $20 in New York, purchasing power parity suggests an exchange rate of 7 baht per dollar, regardless of the actual market exchange rate. This measure can be unreliable because countries vary in how they value specific goods, independent of each currency's purchasing power. As an alternative measure, some economists consider relative purchasing power parity, which compares how purchasing powers change over time.
Step 1
Subtract one country's inflation rate from the reference country's inflation rate. For example, if the United States experiences an inflation rate of 5 percent and Thailand experiences an inflation rate of 2 percent, subtract 0.02 from 0.05 to get 0.03.
Step 2
Add 1 to the compared country's inflation rate. Continuing the example, add 1 to 0.02 to get 1.02.
Step 3
Divide the difference in Step 1 by the sum in Step 2. Continuing the example, divide 0.03 by 1.02 to get 0.029. The relative purchasing power of parity of the Thai baht in regard to the U.S. dollar is 0.029 or 2.9 percent. This means that the dollar will lose value at a rate of 2.9 percent with respect to to the Thai baht.
