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Difficulties
The PPP method is used as an alternative.
For example, if the value of the Mexican peso falls by half compared to the U.S.
dollar, the Mexican Gross Domestic Product measured in dollars will also halve.
However, this exchange rate results from international trade and financial
markets. It does not necessarily mean that Mexicans are any poorer; if incomes
and prices measured in pesos stay the same, they will be no worse off assuming
that imported goods are not essential to the quality of life of individuals.
Measuring income in different countries using PPP exchange rates helps to avoid
this problem.
PPP exchange rates are especially useful when official exchange rates are
artificially manipulated by governments. Countries with strong government
control of the economy sometimes enforce official exchange rates that make their
own currency artificially strong. By contrast, the currency's black market
exchange rate is artificially weak. In such cases a PPP exchange rate is likely
the most realistic basis for economic comparison.
Difficulties
The main reasons why PPP does not perfectly reflect standards of living are
PPP numbers can vary with the specific basket of goods used, making it a rough
estimate.
Preferences and choices can vary from country to country. Goods then differ in
their contribution to welfare.
International competitiveness is mainly affected by the exchange rate and not by
PPP.
Differences in quality of goods are not sufficiently reflected in PPP.
The price of a product within one currency-zone may vary drastically (for
example, the average price of a can of soda is drastically lower in Lexington,
Kentucky than in New York, New York. This is even more noticeable within the
Eurozone.
Imported goods are purchased at market exchange rates, and thus a country that
has to import all of its food would appear better off than it actually is if the
PPP is used as the measurement of well-being.
PPP calculations are often used to measure poverty rates. For problems with this
methodology, see How Not To Count The Poor.
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