Notes on Currency Conversion

Notes on currency conversion:

One problem with GNP estimates: in order to compare them, the GNPs in the local currency must be converted to a common currency-conventionally the US$ by using an exchange rate. If the relative values of the two currencies accurately reflected consumer purchasing power, this simple conversion is acceptable. However, it must be recognized that “the use of official exchange rates to convert national currency figures to US$ does not reflect the domestic purchasing powers of currencies.”

To overcome this deficiency, the UN International Comparison Program (ICP) developed a method of comparing the GNP based on purchasing power parity (PPP). Here’s how its done:

Suppose Thailand reports to the WB that its GNP per capita last year is Bht46,370/capita. The bank must translate this value to USD using the current exchange rate for example Bht 25.2 = US$1 to convert Bht 46,370 to US$ 1,840 (46,370/25.2) How does this measure Thailand’s welfare? What can a Thai citizen consume with the Bht 46,370 compared with what an American can consume with the US$ 23,240 per capita income of the US?

Compare local prices in both countries for the same basket of goods.

Based on the example, Bht 850 buys in Thailand what US$ 107.75 buys in the US. Therefore comparing the purchasing power of the currencies,

Bht 850/US$107.75 = Bht 7.9 per US$1. Using the exchange rate of

Bht 7.9/USD1, Thailands’s GNP/capita is now 46,370/7.9= US$5,870.

At the official exchange rate of Bht 25.2/US$1, Thailand’s GNP/capita is US$1,840.

At the PPP rate of Bht 7.9/US$1, Thailand’s GNP/capita adjusted for PPP is US$5,870.

Purchasing Power Parity (PPP): The number of units of a currency required to buy the same amounts of goods and services in the domestic market as one dollar would in the US.

How PPP is calculated: Compare local prices in both countries of the same basket of