Did you know that the price of 1.5 liters of drinking water in Saudi Arabia is around Rp 8,300 per bottle? Yes! You can buy the same product in Indonesia for about half the price or 3000-4500 rupiah depending on the brand and place of purchase.

The difference in the amount of money to buy the same product in different countries. what does that mean purchasing power parity. Although quite complicated. But this idea will be useful to those who are preparing to travel abroad. Whether on vacation or going to school

Understanding the balance of spending ability

Purchasing power parity is the ratio of the ability of currencies to buy the same goods in different countries. Like the example above, for 10,000 rupiah in Indonesia you can get 2 bottles of 1.5L mineral water, but in Saudi Arabia you can only buy 1.

According to this concept, currencies in two countries can be called equilibrium (equilibrium) or parity if the prices of commodity groups in both countries are equal. Liters in Indonesia and Saudi Arabia are both around 10,000 rupiah.

in macroeconomicsThis concept is important in tuning. gross domestic product. put simply Initially, the value of GDP is calculated in local currency. And it remains only to multiply by the general exchange rate. Hence, calculating the real or nominal value of a country’s GDP. therefore does not reflect the cost of living in that country

With GDP adjusted for PPP, it is more uniform to compare the GDP between one country and another. This is because the concept assumes that price differences between countries “should” be caused only by differences in the exchange rates of these countries’ currencies.

So both policy makers and those in need can make sound international economic decisions. For example, you use US GDP per capita PPP to find the average annual income of Uncle Sam residents in one year. So when you go to school there You have prepared that amount.

according to the team InvestopediaThis indicator is also useful for people who invest in foreign stocks or invest using forex. Forex traders use this indicator to spot the potential of undervalued and undervalued currencies. While stock investors use this indicator to predict the price movements of these instruments against currency changes.

How to Calculate Balanced Spending Ability

The spending power balance formula is:

S = P / P*

information:

S = exchange rate of domestic currency against foreign currency

P = price of a group of goods in domestic currency

P* = price of a commodity in another country in foreign currency

example:

The movie ticket price in Indonesia at the weekend is IDR 50,000 per seat. Movie tickets in America are \$15 per seat. So the exchange rate for movie tickets in America and Indonesia is:

S = 50,000 Indian Rupees/\$15

to balance Let’s convert to all dollars first. As of Dec. 15, 2022, the rupiah to dollar exchange rate is \$1, roughly equal to Rp. 15,600, so Rp. 50,000 equals \$3.2, therefore:

S = \$3.2/ \$15

= 0.22

This means that the \$1 allocated to buy movie tickets in Indonesia is equivalent to ⅕ or 0.2 of the money it would cost someone in the United States to purchase the same ticket. It can also be interpreted that movie tickets in the US are five times more expensive than those in Indonesia.

In addition to the above formula Many institutions, such as the OECD and the IMF, also use a weighted purchasing power balance (Weighted Purchasing Power Parity) for research and economic policy recommendations

Lack of shopping balance

Although the concept of purchasing power balance is important in guiding a country’s economic policy in line with the country’s cost of living. But this concept also has several drawbacks. These shortcomings are often the factor that causes the price difference between two countries. These shortcomings include:

1. Freight

There are times when goods cannot be found in one country and the country must be imported from another country. This results in shipping costs that affect the prices of these products in the respective countries.

For example, mineral water in Saudi Arabia and Indonesia above. Simply put, the price of mineral water in the country is more expensive than the price of mineral water in Indonesia because desert countries are forced to import water from other countries or have to dig very deep to find their source. This problem is relatively unrelated to rainy Indonesia. all year round

2. Tax

Another potential cost of importing or extracting deep water is the cost of taxes. The amount of taxes and customs fees will certainly affect the selling price of goods in a country.

3. Government intervention

Government intervention, such as subsidizing certain goods or systems fixed exchange rate Inevitably affects the price of goods, especially imported goods.

For example, suppose that the price of gasoline in Indonesia is equal to the price of gasoline in Saudi Arabia. Even if Indonesia has to import crude oil from Saudi Arabia. This similarity in prices may have occurred due to the intervention of the Indonesian government in the form of subsidies.

4. Services that are not traded overseas

It is also possible that the same product can be produced in different ways and cost split between the two countries, such as Hollywood movie tickets. in country of origin High-priced movie tickets may include production costs such as actor, director salaries, set rentals, etc., while if the film is screened in Indonesia Movie tickets paid by people in this country are not. include these expenses

5. Competition in the market

Another factor that can affect the price difference in two different countries is the difference in market competition of the respective countries. For example, online motorbike taxi rates in Indonesia are quite expensive than motorbike taxi rates. online in usa This can happen because the online motorcycle taxi market in the US is monopolized. (many manufacturers and buyers) while the Indonesian online motorcycle taxi market oligopoly (There are only a few producers while there are many consumers.) This allows producers to set prices more flexibly.