Relative Form PPP

  

Categories: Econ

See: Purchase Power Parity. See: Relative Purchase Power Parity.

Relative form purchase power parity, better known as relative purchase power parity, is regular purchase power parity (PPP) on steroids...dynamic steroids.

Regular PPP is a way to measure the exchange rate between two different currencies. PPP is when you take two identical goods and compare how much they cost under one currency, like the U.S. dollar. For instance, you can buy some $10 dumplings in the U.S., and buy almost identical dumplings in Thailand for 150 baht, or about $5 USD. Repeat this process with baskets of goods like transport, food, and healthcare, and you’re a PPP master.

Relative form PPP gives us even more information, since it takes the changing inflations of both currencies into account. If you take regular PPP at its word, you’re kind of ignoring inflation, or assuming that it’s the same in both currencies.
Take Venezuela for instance: the bolivar hyperinflated by 42,000% (that’s not a typo). If you took the PPP right before that happened, and right after, you’d get two very different numbers.

This is what relative form PPP avoids by taking inflation into account. It implies that, as inflation goes up, the value of that currency compared to the other goes down.

Let’s say you were able to buy coffee for 500 bolivars, and it now costs 220,000...yet over the same period of time in the U.S., coffee went from $2 to $2.15. Now, you need a lot more bolivars to equal every one U.S. dollar...over 100,000 bolivars instead of 250.

Related or Semi-related Video

Econ: What is the Producer Price Index (...3 Views

00:00

And finance Allah shmoop What is the producer's price index

00:06

or P P I or pit All right short answer

00:10

People A measure of wholesale inflation You know inflation Pump

00:15

air into a football It gets bigger Keep eating Boston

00:18

cream pies and well you'll get bigger Yep those air

00:20

couple of kinds of inflation will in economics Inflation has

00:24

to do with prices when prices get bigger like bigger

00:27

numbers That's inflation A couple of years ago a movie

00:30

ticket cost ten bucks Now it's like twelve fifty That's

00:33

inflation Inflation refers to the amount that prices rise over

00:37

a given time Right We index it We categorize it

00:40

We knew Maris eyes It sort of Inflation is a

00:43

key driver of the pp I At least that's what

00:45

it's measuring But people measures inflation in a specific part

00:49

of the economy See it's relatively easy to see how

00:52

much prices are increasing When you're talking about a single

00:54

product like that movie ticket right You go to the

00:57

store to pick up some adult diapers Eso you Khun

00:59

Stream Black mirror without any You know interruptions Been there

01:03

done that this week A pack of those diapers cost

01:05

you twelve fifty Well last month when you were making

01:08

your way through Season five of breaking bad Well a

01:11

pack back then Cost twelve thirty five Two months from

01:14

now when you're heavy into orange is the new black

01:17

Well you head back to the store and a pack

01:20

of adult diapers is now a twelve sixty So from

01:23

twelve thirty five to twelve fifty two twelve sixty well

01:26

prices are going up up up for adult diapers The

01:29

A D II or adult diaper inflation index is climbing

01:33

fast In just over two months they went up about

01:35

two percent or an annualized inflation rate of around twelve

01:39

percent That's monstrous people means prices at that rate would

01:42

double every six years Well following one products Inflationary tales

01:46

should be pretty easy But when you try to discern

01:49

inflation rates across an entire economy while things get more

01:52

complicated in a dynamic large complex economy like ours well

01:56

prices on different products move different directions at different times

02:00

Adult diapers might see rising prices but at the same

02:03

time prices for ah you know hemorrhoid cream might be

02:06

dropping Meanwhile prices for stool softeners are holding steady different

02:12

items different inflation trends because different parts of the economy

02:15

can have different price trends While there are different economic

02:19

stats to track separate segments of the economy the Producer

02:24

Price Index is one of these The PP I measures

02:26

a particular kind of inflation Specifically it tracks the changes

02:29

in prices for wholesale goods Hence the catchy title ng

02:33

there with the word produce Sir Price Indexing The first

02:36

Pee there Well the P P I is not about

02:38

prices consumers pay at the store Rather the PP I

02:41

follows prices that companies pay to get the raw materials

02:44

they used to make this stuff that shows up in

02:46

the aisles at Walmart or it Amazons warehouses The pp

02:49

I contrast with the C P I or Consumer Price

02:53

Index which measures the retail price is that you know

02:56

the regular Joe consumer pays well Here's a list of

02:59

some of the stuff that comprises the CP I this

03:02

stuff And here's a list of some of the stuff

03:04

that comprises the See Threepio Yeah it's different way digressed

03:08

Okay You make authentic raccoon skin caps to sell Teo

03:11

War of eighteen twelve reenactors you retail the caps for

03:15

a hundred bucks each Last month you paid an average

03:17

of ten dollars for a raccoon pelt The hundred dollars

03:20

retail price represents the consumer price for the cap That's

03:24

what the average Joe pays when he buys it in

03:26

the store Well Meanwhile the ten dollars for the pelt

03:28

represents one of the producer prices you pay You also

03:31

have to pay for string and pelt wax and whale

03:34

oil to run your authentic eighteen twelve era manufacturing facility

03:39

with looms and things But to keep it simple we'll

03:41

just look Att pelt prices for now is a stand

03:44

in for PP I hear this month the price of

03:46

the raccoon pelts goes up to an average of eleven

03:48

dollars each That's ten percent higher from where they were

03:51

last month So the raccoon pelt component of your personal

03:54

PP I was up ten percent from last month to

03:58

this month Well the real life P P I is

04:00

made of a day divers basket of wholesale goods energy

04:03

components like crude oil foodstuffs You know like the stuff

04:07

that contains things like weed or rice stuff like that

04:10

That's a foodstuff and other components that are included in

04:13

it You know from various industries Well they all get

04:15

averaged together to create a single measure or a single

04:18

index The U S government releases a monthly report outlining

04:21

changes in the P P I An increase of point

04:23

one percent or point two percent is considered normal Like

04:27

things go up to percent a year something like that

04:29

Anything above that well could indicate rising inflation pressure Right

04:33

Like prices are about to take off But people don't

04:35

freak out If one month shows a big move commodities

04:37

and wholesale prices tend to fluctuate quite a bit It

04:40

only starts to matter of big gains Start to pile

04:42

up for a few months in a row So even

04:44

though it doesn't measure direct consumer prices the PP I

04:47

represents an important economic measure So pay attention to it

04:51

Your coonskin cap business experience that ten percent rise in

04:54

wholesale prices this month walk the price Then for a

04:57

raccoon pelts rose from ten dollars to eleven dollars So

05:01

you have a decision to make you Khun Pass along

05:03

That cost or expense increased to you to your customer

05:07

increasing your retail price from one hundred bucks a unit

05:10

to one hundred one To cover that increase expensive a

05:12

buck a pelt Or you could just eat the additional

05:15

cost and well live with lower profit margins Usually businesses

05:19

are reluctant to suddenly pass on increased prices to their

05:22

loving customers since commodity markets fluctuate a good deal While

05:25

this month's cost increase can disappear next month and then

05:29

you just kind of forget about it Also retail markets

05:31

are generally competitive The first company to raise prices can

05:35

lose out on shelf space or distribution or customer awareness

05:39

which all Ri leads to a loss of market share

05:41

which would be bad But you went big market share

05:43

If you're going to be the king of the queen

05:45

of pelts selling if you raise your prices and your

05:48

competition doesn't follow suit while customers are going to flock

05:51

to the cheaper brand they get a price advantage because

05:53

well you panicked and raised prices and you really didn't

05:56

need to So if you raise your coonskin price is

05:58

one hundred one dollars Cover the rising costs while furry

06:01

tops might swoop in with a sail and grab up

06:04

a bunch of your customers with lost sales would hurt

06:07

more than a slight dip in profit margins That would've

06:10

happened Have you raised prices a dollar to cover yourself

06:12

So you hold steady and you hope the increased producer

06:14

prices or temporary and will you hold your breath with

06:17

a big oxygen bottle there However a company can't eat

06:20

increased costs forever An upward trend in the PP I

06:23

will eventually find its way to the C P I

06:26

and people is very important There's a lag between the

06:29

FBI and CP I Well the prices for your raccoon

06:31

pelts continue to rise It's eleven bucks this month Next

06:34

month that rise to eleven twenty five the following eleven

06:37

thirty five and six months down the road It's thirteen

06:40

dollars Yeah that's a thirteen bucks Well at that point

06:42

you can't take the expense increases anymore You have to

06:45

increase the price to your customers So you raise the

06:48

price for your coonskin caps to one hundred three dollars

06:51

making up for the three dollar price increase you've suffered

06:54

in buying raccoon pelts over the last several months But

06:56

prices for pelts are so high that furry tops in

06:59

can't swoop in Now with lower prices they have to

07:02

increase prices too because well they've been squeezed with the

07:05

same high pel prices you have And similarly the general

07:09

PP I figures eventually feed into higher retail price levels

07:12

If they don't hire PP I figures eat into corporate

07:15

profits which can impact Stock prices are probably would impact

07:18

stock prices and eventually the overall economy So yeah that's

07:21

the producer price index for pp I a measure of

07:24

wholesale inflation complex but still easier to keep track of

07:29

than all those Boston cream pies you ate last month

07:31

as you continue inflating No just just just just just

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