Purchasing power parity (PPP) is an economic theory that states exchange rates between currencies should adjust until the price of the same goods is equal in different countries when converted to a common currency.

Key features:

• It is based on the law of one price, which suggests that identical items should have the same price in competitive markets globally.
• PPP exchange rates are used to provide a more accurate comparison of GDP, living standards, and economic performance across different countries.
• The Big Mac Index serves as a lighthearted example of PPP by comparing the price of a standard Big Mac burger worldwide to estimate currency value.
• It is very useful for analyzing developing economies where market exchange rates might be influenced by government control or large money movements.
• Limitations include non-tradable goods (like haircuts or housing), transport costs, tariffs, and varying consumer habits between countries.
• Actual market exchange rates often differ significantly from PPP-calculated rates, particularly in countries with lower average incomes.