Purchasing Power Parity, the real value of money
How Everyday Prices Show What Money Is Really Worth
What’s Purchasing Power Parity?
Purchasing Power Parity, or PPP, is a concept that forces us to think beyond exchange rates when comparing currencies. We often hear “The rand is weak because one can only buy 5 cents worth of Dollars” But it isn’t just about exchange rates—it’s about how far your cash in any currency stretches when you go shopping, pay rent, or grab a bite to eat in another country. PPP helps you see if a currency is over or undervalued and lets you compare living standards across the globe.
The Big Mac Index: The Burger Test
To make things fun, The Economist created a currency comparator called the Big Mac Index. It uses the price of a McDonald’s Big Mac in different countries to figure out if currencies are “fairly” valued. For example, in 2024 a Big Mac cost $5.69 in the US but only $2.85 in South Africa (after converting the price to dollars), this means that the Rand is undervalued compared to the dollar. So, for example, if an American tourist arrives in South Africa with a budget of US$ 200 per day he could buy about 70 big mac per day here while he can only buy about 35 big macs per day in his home country. The Big Mac index is not perfect, even the Economist doesn’t take it seriously —after all, a burger’s price can be affected by things like rent and wages—but it’s a handy, memorable way to talk about PPP.
Numbeo: Real People, Real Prices
Numbeo is a website I use to give financial guidance to clients considering emigrating. I was also delighted to see Deutche Bank use it in their research. The site works by gathering the cost of day-to-day goods and services like groceries, rent, transport etc from people all over the world. Instead of just focusing on one item, like a Big Mac, Numbeo covers pretty much everything you’d spend money on in daily life. So, if you are thinking of moving from Port Elizabeth to Vancouver, you plug in your salary in South Africa and Numbeo tells you what you would need in Canadian Dollars to enjoy the same lifestyle as you have in good old SA. So, for example if you are earning R55,000 per month in SA, you would have to earn about R107,000 (8396C$) per month to enjoy the same standard of living in Vancouver. One can see the value of these comparisons for tourists, emigrants and immigrants, and even big companies, knowing how far money goes is key. understanding Purchase Price Parity helps to make sense of what “expensive” or “cheap” really means from one country to another.
It goes without saying that these tools only offer snapshots, not the full picture. A Big Mac isn’t everyone’s lunch. Numbeo’s info relies on its users to update the values. What each person actually spends their money on can throw things off. However, it is important to try to understand the difference between exchange rates and buying power, especially when making huge financial decisions.