Purchasing power parity is used in comparing prices and currency values between two countries in an attempt to determine how exchange rate will change in the long run. The tool helps investors to know whether a given currency is overvalued or undervalued. The theory is based on the argument that exchange rates move up and down in an attempt to get their correct value. This is because an identical basket of goods and services should have the same price (value) in two different countries despite pricing the basket in different currencies. For example, the price of Big Mac should be the same in different countries regardless of the currency used to express its price. The concept of purchasing power parity makes economist say a given currency is either overvalued or undervalued. For PPP to exist there should be two countries using different currencies and one currency should either be overvalued or undervalued. If purchasing power parity doesn’t exist products should flow from the country where they are cheaper to countries where they are expensive as entrepreneurs will be seeking to realize high returns (D & L, 1).
Impact of Technology in Purchasing Power Parity
Technology is used to enhance the accuracy of calculations in determining whether the currency is undervalued or overvalued. In calculating the fair value of currency, it is suitable to use the relationship between GDP and prices. Then a line of best fit is used to determine the adjusted index between Big Mac and GDP per person. Technology is used to give accurate fixing of the line of best fit (D & L, 1).
Technology has hindered the existence of purchasing power parity because people use the internet to shop for lowest prices in the market and place orders online. Thus, currencies adjust themselves from their overvalued level to the correct level because demand for goods that are under priced will increase.
References
D, H., and L. R. "The Big Mac Index." The Economist. The Economist Newspaper, 2016. Web.
