Purchasing-power parity (PPP)

A method of adjusting exchange rates to take account of the different levels of prices in different countries. In the absence of barriers to trade, theory suggests that the prices of goods and services in different countries should be roughly equivalent (allowing for transport costs). In practice, this is rarely the case. But economists calculate PPP exchange rates as a way of assessing whether currencies are under- or over-valued; The Economist does this in a light-hearted way with its Big Mac index (see this article), which uses the prices of McDonald’s burgers.