GDP – (acronym) “Gross Domestic Product,” a measurement to look at the health of a country’s economy. It represents the total value of all goods and services for a specific period of time.
PPP – (acronym) “Purchasing Power Parity,” a theory in economics that compares different countries and different currencies. This ultimately means comparing the purchasing power of two differing currencies by accounting for differences in inflation rates and cost of living.
Both “GDP” and “PPP” are important concepts in economics and are commonly used to talk about how a country’s economy is doing. You may often hear these terms when talking about the state of a national or international economy, like in this article from the National Association of Securities Dealers Automated Quotations, or better known as NASDAQ. NASDAQ is an American stock exchange based in New York and the second largest exchange in the world. This article is about Japan’s GDP, which grew below expectations:
Japan’s Gross Domestic Product grew an annualized 1% in the first quarter of 2017 compared with previous estimates of 2.2%, according to data released by the Cabinet Office. The lower-than-expected growth is being attributed to a fall in oil inventory and lackluster household spending,”
As you can see from terms like “lower-than expected” or “lackluster,” which means “not having force or energy,” Japan’s GDP is not doing as well as people want it to be. When talking about Gross Domestic Product or Purchasing Power Parity, you may see the word written out (like above) or shortened to the acronym form like in this article from Fox News, talking about China replacing the US as having the world’s largest economy in terms of PPP:
Another measure of an economy’s strength is its “purchasing power parity” or PPP—the rate at which the currency of one country would have to be converted into that of another country to buy the same amount of goods and services in each country.
China now accounts for 16.5% of the global economy when measured in real PPP terms, compared with 16.3% for the U.S.
Maybe it’s time to start Seal the Deal Chinese?
Here we can see a short explanation, and the term “real PPP”. “Real” in this case is talking about something specific. It is how much one country or currency, like US dollars or Euros or Yen is worth compared to a different one. It is the rate at which one currency can be exchanged for another. And here, China has a slightly bigger share of the world’s economy compared to the US.
So, China 1 – US 0
Why GDP? and Why PPP?
GDP is used to measure the total amount of goods and services over a period of time. We will often use another measurement – Nominal GDP per Capita – to measure how much the average income for each citizen makes, and is used to examine the wellbeing of cities, regions, and wealth. “Per Capita” means literally “for each head,” and is used to talk about individual people taken as a whole. Nominal GDP per Capita is total GDP of a country divided by the population. As of 2015, the GDP per Capita for the US is approximately $56,000, while China is only approximately $8,000.
Ah, so I suppose that makes it China 1 – US 1.
So does that mean that the average American citizen is seven times richer than an average Chinese citizen? Not necessarily. GDP does not look at how expensive or how cheap the cost of living in a certain place might be. PPP tries to solve this by comparing how much one US dollar could buy a common basket of goods that can be found everywhere.
We calculate PPP in the following way:
“s” = the exchange rate of two difference currencies
“P1” = the cost of a good that can be bought by currency 1
“P2” = the cost of a good that can be bought by currency 2
One way to think of what GDP with PPP represents is to imagine the total collective purchasing power of China if it were used to make the same purchases in U.S. markets. This only works after all renminbi are exchanged for dollars, otherwise, the comparison does not make sense. The net effect is to describe how many dollars it takes to buy $1 worth of goods in China as opposed to in the U.S.
Both the GDP and the PPP are valuable for understanding an economy and the cost of goods, services, and living in a certain place.
How Can Hamburgers Help Us Understand Economics?
The Big Mac Index, or Big Mac PPP is one example of understanding how PPP works, and uses the McDonalds Big Mac as the benchmark, or common economic standard, to measure living costs in different countries. It was first developed by The Economist 1986. Although it is not an exact measurement of costs and currencies in different countries, it is a useful tool for helping understand PPP and values across countries
So how does it work?
Let’s look at the average price of a Big Mac in the U.S. in January 2017. It was about $5.06. In China, it was about 19.60 Yuan. Using the Big Mac Index, we see that it only costs $2.83 based on market exchange rates. So the “raw” or original Big Mac index says that the yuan was undervalued, or below the proper value, by 44% at that time.
If you adjust the Big Mac index so that it is adjusted for the GDP per Capita, however, you can see that it is only slightly undervalued compared to the dollar.
You can check out the Big Mac Index for yourself at The Economist by clicking on this link
Here are some other terms related to GDP and PPP
Nominal GDP Per Capita – (Phrasal Noun) a measure of a country’s economic output that accounts for population. It is used to tell the standard of living in a certain area and tells you how prosperous how citizens feels in each country are.
Currency (N) – a system or type of money
Undervalued (adj) – when something is priced lower than what people believe it should be
Overvalued (adj) – when something is priced lower than what people believe it should be
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