Purchasing Power Parity and Baskets of Goods

External question — Economics Stack Exchange Author: Hans-Peter Stricker Original post: https://economics.stackexchange.com/questions/32389 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. On the exact definition and understanding of "purchasing power parity" it depends what it means when the World Bank defines the “extremely poor” people of the world as those who are currently living on no more than $1 per day per person, measured at the purchasing power parity (PPP) exchange rate as cited e.g. in Duflo/Banerjee's The Economic Lives of the Poor (2006). According to the Wikipedia article on purchasing power parity PPP produces an exchange rate that equals the price of the basket of goods at one location over the price of the basket of goods at a different location. Furthermore it is stated: The goods that a currency has the "power" to purchase are a basket of goods of different types. So PPP depends on a basket of goods, and it seems to be assumed that there is one such basket. But obviously there is none such unique basket: In different countries and in different socioeconomic strata there are very different "typical" baskets of goods - so how to compare these, across countries and strata? In other words (and trying to be specific): What exactly does it mean (according to the official definition) when it is for example said that an Indian farmer (let his name be Kalu) in the state of Rajasthan who exhibits typical consumer behaviour (= has a typical basket of goods, including spendings on religious festivals) is partially self-supplying does a second job as a tourist camel guide does a third job as a quarryman has a monthly income of 10,000 rupies (averaged over a year) lives on $X per day (measured at PPP exchange rate)? But first of all: How exactly would I calculate X - given the information above + the size/structure of his household?

External answer — Economics Stack Exchange Author: Pavel Filip Original post: https://economics.stackexchange.com/a/57868 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. Your argument seems to be going from top to bottom. PPP goes from bottom to top. It is based on the law of one price. That means, assuming perfect goods arbitrage (there's the first catch) and complete markets, meaning that each good is traded in each market (there's the second catch), and assuming away transactions and other costs and a bunch of other things, such as productivity growth differentials (there's yet another catch), price level ratios in any two countries are equal to nominal exchange rates between the two countries.