Purchasing Power Parities (PPPs) are indicators of price level differences across countries. They indicate how many currency units a given quantity of goods and services will cost in different countries. PPPs can thus be used as currency conversion rates to convert expenditures expressed in national currencies into a common currency, eliminating differences in price levels across countries. This common currency is referred to as the Purchasing Power Standard (PPS). PPPs are indicators primarily designed for comparison between countries rather than for comparison over time.
The PPP concept
In their simplest form, PPPs are price relatives that show the ratio of the prices in national currencies of the same good or service in different countries. For example, if the price of a hamburger in Ireland is EUR 2.84 and in the United Kingdom it is GBP 2.20, the PPP for hamburgers between Ireland and the United Kingdom is EUR 2.84 to GBP 2.20, or EUR 1.29 to the pound. In other words, for every pound spent on hamburgers in the United Kingdom, EUR 1.29 would have to be spent in Ireland in order to obtain the same quantity and quality – or volume – of hamburgers.
Published PPPs, usually refer to product groups or broad aggregates like Gross Domestic Product (GDP) rather than to individual products. However, these aggregate PPPs are based on sample surveys of individual goods and services.
Price Level Index
The Price Level Index, expresses the price level of a given country relative to another (or relative to a group of countries like the European Union), by dividing the Purchasing Power Parities (PPP) by the current nominal exchange rate.
If the price level index of a country is higher than 100, the country concerned is relatively expensive compared to the one to which it is compared (for example EU), while if the price level index is lower than 100, then the country is relatively cheap compared to the other country.
Price Level Indices are not intended to rank countries strictly. In fact, they only provide an indication of the order of magnitude of the price level in one country in relation to others, particularly when countries are clustered around a very narrow range of outcomes. The degree of uncertainty associated with the basic price data and the methods used for compiling PPPs, may affect in such a case the minor differences between the PLIs and result in differences in ranking which are not statistically or economically significant.
The convergence or divergence of prices among countries is of interest in a number of contexts such as competition policy and consumer protection. PLIs provide a means of observing the movement of price levels over time, but they have to be used with caution. First, except within the euro area, they are influenced by exchange rate fluctuations (being the ratios between PPPs and exchange rates). Second, independently of exchange rates, they are volatile. This is generally so at the lower aggregation levels where sample sizes are small. Usually such volatility diminishes, if not disappears, with aggregation.
Volatility particularly arises when the basket of goods and services to be priced changes from one price survey to another in order to accommodate market developments. For example, in this respect, the basket for Food and Non-Alcoholic Beverages is relatively stable, while that for electronic goods is altered substantially each time it is surveyed. Volatility of this type also diminishes with aggregation. For these reasons, PLIs are better suited to monitoring price convergence at higher levels of aggregation over long periods of time.
The PLIs for household final consumption expenditure are sometimes used to measure the differences in the cost of living between countries. This is correct to the extent that they indicate whether the overall price level for consumer goods and services faced by the average household in one country is higher or lower than the overall price level for consumer goods and services faced by the average household in another country. Households or individuals considering moving from one country to another for reasons of employment, retirement or even a holiday should exercise caution when attempting to infer from these measures of overall price levels how the change of country will affect their cost of living. The PLIs for household final consumption expenditure reflect the expenditure pattern of the average household which in all likelihood is different from that of the household or individual contemplating the move. Also, the PLIs are national averages and they do not reflect differences in the cost of living between specific locations such as London and Paris or the Côte d’Azur and the Costa del Sol.
The impact of exchange rate changes on PLIs
PLI for a given country is calculated as its purchasing power parity (PPP) divided by its annual average exchange rate to the euro. This implies that exchange rate movements have an impact on the PLIs. A depreciation of a country's currency against the euro will make the country cheaper in comparison to euro area countries and this will show as a decrease of the relative price level expressed in the PLI. The major price level change observed in 2018 can be at least partly explained by fluctuations of country's currency against the Euro. In 2018, the national currency of Turkey showed a large depreciation (39% between 2017 and 2018).
Within the framework of the Eurostat-OECD Purchasing Power Parities (PPP) programme, surveys on prices of household goods and services are carried out cyclically by the National Statistical Institutes (NSIs) of 37 countries. Each survey cycle comprises 6 surveys, each related to a particular group of household consumption products. As 2 surveys are run per year, the whole survey cycle takes 3 years to conclude, before the next cycle starts. The prices used for this publication were collected in Spring 2018. The PLIs presented in this article are based on annual national average prices for about 440 goods in total. The expenditure shares reported in this article are based on national accounts data for 2018 and represent the average over all participating countries. The national accounts data are also used as weights in the aggregation of detailed PLIs to aggregate PLIs
In Ireland we priced just over 400 items and collected just over 6,300 prices. The prices were collected in Dublin in a variety of outlets mainly in Supermarkets and specialty stores e.g. Greengrocers, Butcher shops, Fishmongers, Off Licence stores etc. Price collections took place in Dublin City and Suburbs during April 2018.
Purchasing Power Parities (PPPs) are mainly designed for:
The main use of PPPs is to convert national accounts aggregates, like the Gross Domestic Product (GDP) of different countries, into comparable volume aggregates. Applying nominal exchange rate in this process would overestimate the GDP of countries with high price levels relative to countries with low price levels. The use of PPPs ensures that the GDP of all countries is valued at a uniform price level and thus reflects only differences in the actual volume of the economy.
PPPs are also applied in the analysis of relative price levels across countries. For this purpose, the PPPs are divided by the current nominal exchange rate to obtain a Price Level Index which expresses the price level of a given country relative to another, or relative to a group of countries like the EU28.
PPPs are also used in the analysis of price convergence.
PPPs are not designed for:
Strict ranking of countries without taking statistical error margins into account
Calculating national growth rates
Industry-specific output and productivity comparisons
Cost-of-living comparisons for individuals
Assessing potential undervaluation or overvaluation of currencies or use as equilibrium exchange rates
What type of Products are priced?
As already outlined Price Level Indices are derived from Purchasing Power Parities. Purchasing Power Parities, in their most elementary form, are price ratios for a comparable product (a good or a service) in different countries. Prices in the national currency serve as a starting point. Comparisons on the basis of PPPs are thus founded on ratios of purchaser prices in different currencies for identical or comparable products (e.g. 1 kg rice, 1 bottle of whiskey). These goods and services are carefully defined in detailed product descriptions, at a European level, prior to the price survey and are selected taking into account their representativity. An overview of the product types for the Food, Beverages and Tobacco survey is given below.
Bread and Cereals: rice, other cereals, flour and other cereal products, bread, other bakery products and pasta products.
Meat: beef and veal, pork, lamb, mutton and goat, poultry, other meats and edible offal, delicatessen and other meat preparations.
Fish: fresh, chilled or frozen fish and seafood, preserved or processed fish and seafood.
Milk, Cheese, Eggs: fresh milk, preserved milk and other milk products, cheese, eggs and egg-based products.
Oils and Fats: butter, margarine, other edible oils and fats.
Fruits, Vegetables and Potatoes: fresh or chilled fruit, frozen, preserved or processed fruit and fruit-based products, fresh or chilled potatoes, frozen, preserved or processed vegetables and vegetable-based products.
Other Food Products: sugar, jams, marmalades and honey, confectionery, chocolate and other cocoa preparations, edible ice, ice cream and sorbet and food products n.e.c.
Non-alcoholic Beverages: coffee, tea and cocoa, mineral waters, soft drinks and concentrates, fruit and vegetable juices.
Alcoholic Beverages: spirits, wine and beer.
Survey prices to National prices
After each survey all countries are required to provide Eurostat with spatial adjustment factors in order to adjust average prices obtained from one or more locations within the economic territory of a participating country to national average prices. According to the PPP Regulation they are required to measure regional differences in price levels once every six years.
The spatial adjustment factor Ireland submitted was based on Consumer Prices data.
National prices to annual national prices
The national survey prices, irrespective of whether they are adjusted capital city prices or national prices supplied directly by countries, refer to the point in time when the survey was conducted, for the Food Beverages and Tobacco Survey this was April 2018. They are not annual prices and need to be adjusted accordingly. To this end, participating countries are required to provide Eurostat or the OECD with monthly temporal adjustment factors with which the national survey prices can be converted to national annual prices. Ireland supplies Eurostat with the required Harmonized Index of Consumer Prices (HICP) data for this purpose.
Type of prices collected
The aim of the survey is to collect the prices that purchasers would have to pay if they were to actually purchase the goods and services specified at the time of the survey.
For the purpose of the Food, Beverages and Tobacco survey VAT and other indirect taxes e.g. excise duty are included. For the 2018 discounts were included.
What does all this mean?
It is important to note that PLIs are national averages and they do not reflect differences in the cost of living between specific locations such as London and Paris or the Côte d’Azur and the Costa del Sol.
As already mentioned, PLIs are not intended to rank countries strictly. In fact, they only provide an indication of the order of magnitude of the price level in one country in relation to others, particularly when countries are clustered around a very narrow range of outcomes.
PLIs can provide a means of observing the movement of price levels over time, but they have to be used with caution. First, except within the euro area, they are influenced by exchange rate fluctuations (being the ratios between PPPs and exchange rates). Second, independently of exchange rates, they are volatile. This is generally so at the lower aggregation levels where sample sizes are small. For these reasons, PLIs are better suited to monitoring price convergence at higher levels of aggregation over long periods of time.
The Consumer Price Index is a more reliable measure of the development of prices in a given country. Similarly, if we want to compare the rate of price change in two or more countries the Harmonized Index of Consumer Prices (HICP) is readily available, at least for European Countries.
A time series of PLIs shows, for each consecutive year, the various countries’ price levels in relation to each other, and provides a rough indication of how these relative price levels have developed.