Purchasing Power parity
A purchasing power parity exchange rate takes into account the different purchasing power of currencies in their home countries for a given basket of goods.
- For example, one dollar will buy more goods in China than in UK. This is because the cost of living is cheaper in China. Real exchange rates don't often take this into account.
PPP give a better comparison of living standards of two or more countries than using gross domestic products (GDP) using market exchange rates.
PPP is not straight forward because of the difficulties of finding comparable baskets of goods to compare purchasing power across countries.
Related Essay: TO what extent does GDP measure living standards
PPP has implications when comparing living standards for instance, GDP per capita in the People's Republic of China is about US$1,800, while on a PPP basis it is about US$7,204.