Purchasing power of currencies: How to understand purchasing power parity in the global economy

Why buy more in one country for the same money?

Imagine a scenario: the same ordered purchase costs you 5,000 CZK in the Czech Republic, but only 1,500 CZK in Vietnam. It's not magic – it's purchasing power parity, an economic principle that explains why your money behaves differently in different countries.

What does purchasing power parity really mean?

Purchasing power parity is essentially an answer to the question: “How much can I buy with my salary in different places in the world?” It is not a complicated concept. It is about comparing what you can actually afford to buy for the same amount of money in different countries.

Economists calculate it by tracking a basket of household purchases – food, clothing, housing, energy – and comparing how much the prices of these items differ between countries. If you spend 200 CZK on a snack in the Czech Republic that costs only 80 CZK in Poland, purchasing power parity helps you understand which currency actually has greater purchasing power.

Law of One Price: a theory that does not hold perfectly

The core idea is the so-called law of one price. It states that the same product should cost the same everywhere, taking into account the exchange rate. In an ideal world, this would work flawlessly.

The reality is more complicated. Taxes, transportation costs, local demand and supply – all of these increase or decrease prices. For example, an iPhone costs differently in the USA than in Japan, even though it is an identical product. Here, purchasing power parity becomes a useful tool – it shows us how these differences arise and what they say about the economic strength of individual currencies.

Why should purchasing power parity be on the radar?

Accurate measurement of the economic level of lives

When we compare the GDP of countries using current exchange rates, we can be misleading. Take India: its GDP per capita seems low when using the nominal exchange rate. But when we adjust it for purchasing power parity, which takes into account lower living costs, the picture changes completely. People can actually afford more than it might seem.

The International Monetary Fund and the World Bank therefore use GDP adjusted for purchasing power parity – thus obtaining a more realistic picture of the global distribution of wealth and the economic performance of individual countries.

Comparison of real incomes

Does it make sense to compare salaries between countries? You have 100,000 CZK per month – is that more or less than the average salary elsewhere? Purchasing power parity will tell you that in the Czech Republic you can afford a lot with that, while in Switzerland it would barely be enough. It's about how much you can actually afford to buy, not just the nominal number.

Prediction of where the exchange rates will go

Exchange rates are constantly evolving. Politics, inflation, economic data – all of these have an impact. Purchasing power parity serves economists as a compass for navigating long-term forecasts. Exchange rates gradually converge towards what purchasing power parity indicates, making it a tool for predicting medium-term currency developments.

Currency Fraud Detection

Sometimes governments officially set the exchange rates of their currencies to make them look stronger than they are. However, purchasing power parity is an objective tool – it reveals when the actual value of a currency does not align with what the official figures tell you.

Big Mac, iPad and how reality is measured

It is not a coincidence that the weekly magazine The Economist came up with the Big Mac index. It is a brilliant trick: because Big Macs are almost the same everywhere, their price quickly shows you how the purchasing power of currencies differs. In the Czech Republic, a Big Mac costs about 100 CZK, while in India it is only 60 CZK – and you already know what this means for the relative strength of currencies.

This principle has expanded over time. Today, you have the iPad index, the KFC index, and dozens of others. They all operate on the same principle – you take a common, globally available product and compare its price. This immediately makes it clear how purchasing power parity works in practice.

Where Purchasing Power Parity Meets Reality: What Doesn't Work

The theory is beautiful, but reality is more complicated.

Quality is not always visible: A product that looks the same may have a higher price in one country because it is of better quality. Therefore, your comparison may not be accurate – it is not always “apples to apples”.

Non-tradable items: Real estate, services, electricity – these items are not traded internationally. Their prices often vary dramatically depending on local conditions. Purchasing power parity is therefore less accurate for them.

Inflation takes your time: Price comparisons that are relevant today may become outdated in a few months. Inflation progresses at different rates in different countries, making the data obsolete.

How the purchasing power parity relates to cryptocurrencies and stablecoins

Bitcoin and other cryptocurrencies are not tied to any country – they are global. However, this does not mean that purchasing power parity is not relevant.

For people in countries with weaker currencies ( according to purchasing power parity ) buying Bitcoin is more expensive – and that is precisely why Bitcoin has become interesting in these regions. When your local currency devalues or inflates, cryptocurrency can become a way to preserve purchasing power.

Similarly, stablecoins are a practical solution in countries with high inflation or weak currencies. Instead of keeping money in a currency that is losing value, one can convert it to a stablecoin pegged to the dollar or euro. Purchasing power parity plays a key role here – it helps people understand when it is worthwhile to convert local currency to crypto assets and when it is not.

Conclusion: Purchasing power parity is the key to understanding the world

Purchasing power parity is not just an abstract economic metric. It is a knife that cuts through the flash of numbers and seeks the truth about how much people in different parts of the world can truly buy. It is not a perfect tool, but it gives you a framework to fairly compare the economic strength of countries.

Whether you want to understand why your salary is valued differently in Germany than in the Czech Republic, or why Bitcoin behaves like a currency in Argentina, purchasing power parity will help you with that. And in the era of global currencies and cryptocurrencies, it's knowledge that everyone should possess.