Why your money buys less or more in different countries – Purchasing power parity explained

The Reality Behind Strange Price Differences

Have you noticed that the same product costs differently in the Czech Republic than in Germany or India? The answer lies in the economic concept known as purchasing power parity – a tool that allows us to understand how the actual value of money varies by location. Simply put, it’s about how many things you can truly afford to buy with your money in different countries.

How is the true strength of your wallet measured?

The basis of purchasing power parity is the idea that the same goods should have the same price when considering local exchange rates. This principle is called the law of one price. In practice, it works such that economists do not track just one product, but a whole basket of goods – food, clothing, energy, housing, and other items that people typically spend money on.

By comparing this consumer basket in different countries, you can get an idea of the purchasing power of your currency. If you have a salary of 100,000 crowns per month, in one country you can afford a comfortable apartment and a Judas, while in another it barely covers your rent.

Big Mac, iPad and life in different countries

Would you like to understand purchasing power parity in practice? The most famous example comes from The Economist and is called the Big Mac index. The idea is brilliantly simple: since McDonald's sells the Big Mac almost everywhere in the world with the same recipe, its price in different countries will immediately tell you something important about the local currency.

When a Big Mac costs 100 CZK in the Czech Republic but only 60 CZK in India, it means that the Indian rupee actually has greater purchasing power for certain goods. Over time, this comparison has expanded to include the iPad index, KFC index, and other products. These “indexes” are not just for fun – they are practical tools for seeing purchasing power parity in real life.

Where is purchasing power parity used and why is it important

The International Monetary Fund and the World Bank continually monitor GDP adjusted for purchasing power parity. Why? Because the mere exchange rate can be misleading. Take India – when you look only at its GDP converted at the standard rate, it seems low. However, when you take into account lower living costs and purchasing power parity, you find that the average Indian can buy a number of things cheaper than, for example, a Czech.

In this way, economists gain a clearer picture of the global distribution of wealth and the standard of living in individual countries. It also helps to predict how exchange rates will behave in the long term – although exchange rates fluctuate in the short term due to politics or stocks, in the long run they tend to converge towards what is indicated by purchasing power parity.

Cryptocurrencies and Purchasing Power Parity – A Hidden Connection

Purchasing power parity has an interesting application in the world of cryptocurrencies. Bitcoin and other digital assets are not tied to a specific country. For people in countries with weaker currencies (according to purchasing power parity), buying Bitcoin or other cryptocurrencies may be more expensive, and it can also become an interesting hedge against the devaluation of the local currency.

In countries with high inflation or hyperinflation, stablecoins play an increasingly important role. When your local currency is rapidly depreciating, converting to a stablecoin – which is usually pegged to the US dollar – allows you to preserve purchasing power. Purchasing power parity plays a key role in such decisions: it helps people understand whether it makes sense to convert the local currency into digital assets.

Limitations and Issues of Purchasing Power Parity

Nothing is simple. Purchasing power parity has significant limitations. First, there is the quality of goods – a product that costs more in one country may be of better quality, even if it looks the same. Secondly, there are non-tradable goods – real estate, hairdressing services, or electricity are not traded internationally, and their prices vary drastically depending on local conditions.

Another problem is inflation and time. Purchasing power parity assumes price stability, but we know that inflation changes that. Price comparisons that make sense today may be outdated in a few months.

Conclusion: An Important Tool for Understanding the World

Purchasing power parity is not perfect, but it is a powerful tool. Whether you are an investor considering buying cryptocurrencies, an employee about to work abroad, or just a curious person wondering why bread is more expensive in Germany – purchasing power parity will help you understand the real differences in economic conditions between countries. Simply put, it shows you how much you can really buy with your money, regardless of what country you are in.