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GDP and Purchasing Power Parity (PPP)

AS, A-Level, IB
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Last updated 7 Jun 2023

Why is purchasing power parity used when assessing relative living standards between countries?

When assessing comparative living standards, Purchasing Power Parity (PPP) is used to account for the differences in price levels between countries, enabling a more accurate comparison of income and purchasing power. By adjusting income figures with PPP, we can better understand the affordability of goods and services in different countries.

Let's consider an example to illustrate how PPP affects comparative living standards. Suppose we want to compare the living standards between Country A and Country B.

Country A has a nominal GDP per capita of $50,000, while Country B has a nominal GDP per capita of $40,000. At first glance, one might assume that the living standards in Country A are higher. However, when we take into account PPP, the picture might change.

If the PPP exchange rate between the two countries is 0.8 (meaning that the currency of Country B is undervalued compared to Country A), we can calculate the PPP-adjusted GDP per capita for both countries.

PPP-adjusted GDP per capita of Country A = $50,000 PPP-adjusted GDP per capita of Country B = $40,000 * 0.8 = $32,000

In this case, despite having a lower nominal GDP per capita, Country B has a higher PPP-adjusted GDP per capita. This indicates that the average person in Country B can purchase a comparable basket of goods and services at a lower cost than in Country A.

By using PPP, we gain insights into the relative purchasing power and standard of living in different countries. It helps us understand how far income can go in terms of meeting basic needs, accessing goods and services, and maintaining a certain standard of living. This information is essential for policymakers, economists, and researchers to make informed decisions regarding economic development, poverty reduction, and inequality alleviation.

It's important to note that actual PPP data can vary over time and across different sources. International organizations such as the World Bank and the International Monetary Fund (IMF) regularly publish PPP estimates based on comprehensive surveys and data collection efforts. These estimates provide a basis for comparing living standards and making meaningful cross-country analyses.

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