Purchasing Power Parity

Purchasing power parity is the exchange rate that makes the cost of an item the same in two countries. If an item costs £100 in the United Kingdom and $150 in the United States there is purchasing power parity if the exchange rate is £1=$1.5. The item effectively costs the same in both countries. Purchasing power parity cannot apply to immobile goods such as houses and it does not take into account distortions caused by transport costs and trade restraints so standard goods that are widely available in both countries are used as a measure. Purchasing power parity can be used to suggest the correct level of an exchange rate and whether it is over- or undervalued. It also allows comparisons to be made between countries' incomes and gross domestic product (GDP) as it takes into account the purchasing power of different currencies in their home countries.

See also: Base Currency, Quoted Currency, http://www.oecd.org/department/0,3355,en_2649_34357_1_1_1_1_1,00.html