## April 02, 2017

### PURCHASING POWER PARITY THE COMPARISON OF PETROL PRICES IN ASEAN

PURCHASING POWER PARITY
THE COMPARISON OF PETROL PRICES IN ASEAN
DR MUZAHET MASRURI

You may have seen the comparison of prices of petrol between a country with other countries by means of converting the prices of petrol in respect to the currency of a particular country. The examples are shown in the following diagram.

From the naked eye, the above comparison explains the difference in petrol prices between those countries. However, this comparison is incorrect and not according to method commonly used in the economic analysis. This is because the comparison between countries should take into account factors such as differences in currency, economic structure, level of the countries development, national income, inflation, cost of living and other factors which are different between those countries.

Purchasing Power Parity (PPP) is the method commonly used in economic analysis in comparing the prices of goods and services between countries. The method presumed that the cost / price of the basket of goods to be compared should be the same among countries and the price is converted to the prevailing foreign currency exchange rate. In other words, it means that the quantity of currency needed to buy a unit of goods and services should be the same among the countries compared.

In general, PPP is a price index similar to the Consumer Price Index (CPI) in terms of concept and method of calculation. The only difference is the CPI index measures price changes from time to time. On the other hand, the PPP index measures the price level differences between countries.

This article compares the prices of petrol (RON95) in ASEAN countries, using the index of Purchasing Power Parity (PPP). The comparison is based on the price of RON95 on January 1, 2017. The method of calculation of PPP Index of RON95 is shown in Table 1.

Column (2) is the price of RON 95 stated in local currency on 1 January 2017.

Column (3) is the PPP in USD. It is calculated by dividing the price of petrol in the respective countries with the price of petrol in the United States. For example, PPP in USD for Singapore is 1.99 / 2.08 = 0.95. This means that users pay SGD 0.95 for a liter of RON95 in Singapore as compared with USD1.00 in the United States.

Column (4) is the currency exchange rate for each country against the USD. For example, in Malaysia in January 2017, USD1.00 is equivalent to RM4.45.

Column (5) is how much money is needed to pay USD per liter of RON95 in ASEAN countries. For example, in Malaysia the amount is derived by dividing the price of petrol in Malaysia with USD (2.30 / 4.45 = 0.52). The index shows the price of a liter of RON95 in Malaysia as compared to the price in the United States (USD2.08). The same Column also shows the price of a liter of RON95 in other countries in ASEAN as compared to the price in the USA.

Finally, Column (6) is the PPP Index, i.e. the price in USD is required to buy a liter of RON95 in ASEAN countries. For example, in Indonesia the price index is 0.61 / 2.08 = 0.29.

The summary of the result in Column (6) is also shown in Table on top of the article. This index should be used in comparing the prices of RON95 in the ASEAN countries observed.

In conclusion, it is incorrect to compare the prices of petrol (RON95) between countries in ASEAN by means of converting the prices in respect to the Malaysian currency (ringgit). The comparison should apply the commonly used method of Purchasing Power Parity (PPP).