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The Big Mac Index

The purchasing power parity otherwise known by its standard initials PPP is an economic theory used to explain currency relationships between countries (Ruiz-Nápoles, 2004). Economist used the theory to explain the exchange rates between countries’ currencies and how changes in purchasing power offset to ensure equilibrium in exchange rates. The changes in PPP area known to have significant impact on a country’s price levels especially for a fixed basket of products (Ruiz-Nápoles, 2004). The connections between price levels and exchange rates is defined by the belief that when a country’s exchange rate depreciates the country’s domestic prices for goods and services must increase to set PPP at equilibrium. With an increase in commodity prices, the country will be facing instances of inflation, and the economy is said to be worsening.

In his theory of the important role of government, Adam Smith advocated for limited market control by the government with the belief that an economy would be sufficient if forces of demand and supply were left to interact and eliminate any inefficiency (Ignatiuk, 2009). Devaluation or revaluation of currency exchange rates is an action of the government, which contradicts the principles of free market operations, and therefore becomes a constraint factor towards setting a balance between prices of goods and services and currency exchange rates (Ignatiuk, 2009). The big question therefore is whether the devaluation and overvaluation of US dollar against other currencies create equilibrium between exchanges rates and prices of products for similar baskets across the represented countries (Ignatiuk, 2009). Since a country to which the US dollars is devalued imports at lower prices, the possibility of achieving equal prices for the same product or service across different countries becomes minimal and contrary to the concepts of PPP. 

References

Ignatiuk, A. (2009). The Principle, Practice and Problems of Purchasing Power Parity Theory. München: GRIN Verlag. Press. Web. 02 Jan 2015. Retrieved from https://books.google.com/books?id=ooJmUiQrvRsC&printsec=frontcover&dq=the+purchasing+power+parity&hl=en&sa=X&ei=1tGmVJ-1BM37avyggYgO&ved=0CC0Q6AEwAw

Ruiz-Nápoles, P. (2004). The Purchasing Power Parity Theory and Ricardo’s Theory of Value. Contributions to Political economy, 23(1), 65-80. Web. 02 Jan 2015. Retrieved from http://scholar.google.com/scholar_url?url=http%3A%2F%2Fcpe.oxfordjournals.org%2Fcontent%2F23%2F1%2F65.short&hl=en&sa=T&ct=res&cd=0&ei=0EKmVK6fH-bs0AHVvYDAAw&scisig=AAGBfm1_aR3z2JI33VpBeS-KQ7tGZTKYSQ&ws=1280×689