welcome today we're going to be looking
at GDP gross domestic product and PPP
purchasing power parity these are very
useful concepts if we want to compare
the economy of two different countries
let's take a look gross domestic product
as you probably know is the market value
of all final goods and services produced
within a country in a year I'm not going
to say so much about gross domestic
product and its problems and its
measurement because you can find this
material in just about any textbook of
course I recommend that you choose the
best textbook let's move on the problem
we want to solve is this how do we
compare let's say twenty ten US gdp of
14.5 trillion dollars with the GDP of
Thailand which in Thailand is measured
as nine point five trillion bat well the
obvious idea is to use exchange rates
and indeed if we do this we find that
one dollar is equal to about thirty one
bat this point in time so thi gdp by
this measure is approximately 300
billion US dollars there are two
problems however with using exchange
rates to convert GDP the first is that
exchange rates swing a lot and this
implies implausibly large swings in the
standard of living so it wouldn't be at
all impossible for example for the tie
to US dollar to bat exchange rate to
swing by you know thirty percent within
a couple of months either up or down but
this just implies much bigger changes in
the standard of living in these two
countries than is really very plausible
the second problem is that exchange
rates are more relevant to goods that in
fact are exchanged to tradable and less
relevant to non-tradable such as many
services in fact it turns out that
non-tradable tend to be cheaper in poor
countries that's an important fact we
want to say a little bit more about
manufactured goods tend to sell for
similar prices everywhere this is the
law of one price for tray tables so for
example if you want to buy an iPad it's
going to cost you about five hundred
dollars whether you buy it in the United
States whether you buy it in France
after you've converted the currency
whether you buy it in China even if you
buy it in Outer Mongolia it's still
going to cost you when all is said and
done about five hundred dollars and the
reason for this is imagine that iPads
were selling for three hundred dollars
in Outer Mongolia iPads are trainable
they can easily be moved around so if I
pads were selling for three hundred
dollars in Outer Mongolia and five
hundred dollars in the United States it
would make sense to buy iPads in Outer
Mongolia for 300 shipped into the United
States sell them there for 500 until the
prices equalize the same is not true for
services services tend to be quite a bit
cheaper in poorer countries you can get
cheap haircuts cheap cooks and keep
house cleaners in a poorer country this
is because labor is non-tradable labor
at least in our world is immobile so for
example you can get a cheap cook in
India an expensive cook in the United
States but you don't see lots of cooks
moving from India to the United States
at least not compared to the numbers of
people who could move so the exchange
rate because of this is more closely
related to the relative price of
tradable goods tradable goods will be
exchanged through the arbitrage process
I just discussed until in fact the
exchange rate makes it such that
tradable goods sell for about the same
price everywhere once you've done all
the currency conversions the same is not
true for labor the same is not true for
service goods for goods for non tray
tables for immobile goods so where as a
result of this calculation calculations
of GDP based on exchange rates tend to
overestimate the cost of living in poor
countries because they take into account
a tray tables are about the same price
but not
that non-tradable are cheaper in poorer
countries this is called the bellassa
Samuelson effect and you can find more
about it by listening to the video on
bella bellassa ok given this how do we
compare gdp of two different countries
well we're going to use a method very
similar to what we do to compare gdp
over time in the same country so let's
remember what nominal gdp is so nominal
gdp is just the market value of all
final goods and services sold in a
country within a year so for example if
we want to look at nominal GDP in the
United States in 2005 that's 2005 prices
times 2005 quantities turns out to be
equal to twelve point four trillion
dollars if we look at 1995 GDP in the
United States that's 1995 prices times
1995 quantities at seven point four
trillion dollars the growth of nominal
GDP then subtracting these numbers that
turns out to be equal to sixty seven
point six percent we really don't think
however that the growth in the living
standard has gone up by sixty-seven
percent between 1995 and 2005 is the
growth of nominal gdp over this ten year
period includes price increases as well
as increases in output so the solution
to this problem is to calculate GDP in
each year using the same set of prices
so for example we can calculate 2005 GDP
just as we did before as 2005 prices
times 2005 quantities that's again to
twelve point four trillion dollars now
however let's calculate 1995 gdp in 2005
dollars that is we're going to use 2005
prices times 1995 quantities that gets
us 1995 gdp in 2005 dollars and that's
9.0 trillion dollars so the growth rate
of real GDP
is turns out to be thirty seven point
eight percent not bad but not the
sixty-seven percent that we saw earlier
so the idea here is that using the same
set of prices eliminates the effect of
price changes on GDP let's try the same
trick for comparing the economies of two
different country so to compare gdp over
time we create a basket of goods which
is comparable over time and we look at
how the price of that basket changed
over time so we can find for example
that a basket of goods which costs ten
dollars in 1915 we can trace that same
basket all the way through 2005 where it
cost two hundred and seven dollars we
can use that series of price changes to
calculate real gdp over time let's use
the same idea for comparing GDP between
countries we need to create a basket of
goods which is comparable between
countries and look at the prices of that
basket in different countries if we do
this when we find for example that the
price for the basket is PA in country a
and PB in country B then the purchasing
power parity ratio is PA to PB that is
the number of units of country A's
concei that are needed to purchase the
same basket of goods and services as one
unit of country B's currency will
purchase in country B okay that's kind
of a mouthful so let's give an example
let's take a look at the most famous
purchasing power parity ratio or index
the Big Mac index which is produced by
the economist the Big Mac is a basket of
goods it's a basket of bread and beef
and cheese and onions and also the labor
required to cook these products and to
deliver them so in the United States
this basket of goods can be bought for
about four dollars and forty-five cents
in Thailand the exact same basket the
same Big Mac you can buy for seventy bat
what that suggests for example is that
somebody who are in 70 bat an hour in
Thailand has above the same standard of
living as somebody who earns four
dollars and forty-five cents an hour in
the United States notice however that
the actual exchange rate is not one
dollar to 15.7 for bat it's actually 12
29.6 bat in other words if you take that
70 bat in Thailand and you convert it
into dollars you're only going to get
two dollars and thirty six cents this
might suggest if you used the exchange
rate to look at standard of living this
would suggest that somebody who are in
70 bout an hour in Thailand actually has
a standard living equivalent only 22
dollars and thirty six cents an hour in
the United States while in fact we know
the actual equivalent is four dollars
and forty-five cents an hour we know
that the person in Thailand can afford a
Big Mac not just half a Big Mac as the
exchange rate would suggest well why is
this well this is the bilasa Samuelson
effect it's the fact that the Big Mac
contains a labor component and labor is
cheaper in Thailand which means that
it's cheaper to live in Thailand then
you would expect from the exchange rate
alone another way of putting that is
that people in Thailand have a higher
standard of living than you would expect
given the exchange rate alone this is
why we want to convert using purchasing
power parity ratios rather than using
exchange rates by the way you can also
see that down here where it's actually
cheaper to live these tend to be poorer
countries right well up here where the
exchange rate is you could say
overvalued okay we're a Big Mac cost you
eight dollars for example in Norway
these tend to be the richer countries
again this is very consistent with the
bilasa Samuelson effect so remember we
want to convert using the purchasing
power parity ratios in order to take
into account that some goods
particularly
non tradable goods are cheaper in poorer
countries and we do that by using the
same basket of goods in all countries
the Big Mac index gives us the right
idea but we'd really like a bigger
basket of goods after all the Big Mac
doesn't include everything so this is
what the World Bank's international
comparison program does it creates a
very large basket of goods to try and
create PPP adjusted real gdp by the way
when you do this Thailand's GDP based on
exchange rates is 300 billion when you
do it based on PPP which for all the
reasons we've discussed is a more
accurate account of the strength of an
economy or the standard of living it's
585 billion a larger number now it's
very difficult to make real GDP
comparisons over long periods of time
this is because it's difficult to find a
comparable basket of goods over periods
of time we consume a lot of goods today
like iPads which simply weren't
available 20 years let alone 80 years
ago we also change our consumption
patterns over time so we consume a lot
fewer horse shoes today than we did a
hundred years ago but if horse shoes are
a little bit more expensive today you
wouldn't want to say that that means our
standard of living has gone down a lot
goods change in quality over time as
well we have very similar problems when
we're trying to make comparisons of GDP
between very different countries let's
take a look so how we going to make this
international basket comparable we have
a number of problems first I'll call the
rice problem well rice seems like
something we ought to be very easily
able to compare across countries but yet
when you look in more detail you say
well are you comparing long grain rice
or short crane crane rice brown rice or
white rice Uncle Ben's or kismet rice so
all kinds of different types of rice and
we need to try
best as we can to make account of those
differences there's also what I call the
qua solved problem for some reason
classes are just a lot better in Paris
than they are in Washington DC you can
go to a bakery right off the street in
Paris and the class on just tastes a lot
crunchy ER and crisper and yet soft
inside than the one you buy in
Washington DC so there are quality
differences which we'd like to take into
account if we possibly can but of course
that is hard to do then there's the
cheese problem or the consumption weight
problem we consume a lot of cheese in
the United States they don't consume
very much in China so if cheese is more
expensive in China than it is in the
united states that doesn't mean that the
Chinese have a lower standard of living
because they don't want to buy the
cheese anyway so we have to try and take
into account this basket of the goods
has to be comparable across countries so
we don't want to use the US consumption
ratios in fact we don't want to use the
Chinese consumption ratio is either we
want to try and create some middle
ground then there's a health care
problem how do you measure the prices of
goods which aren't bought and sold in
markets health care is a big part of gdp
and yet for the most part we don't have
prices for a heart surgery or for
diabetic treatment or something like
this so in this case is we usually
measure by the cost of the inputs which
is not as good a solution then
everything that I've said so far also
applies we want to look at producer
goods you know the welding equipment how
are you going to find comparable welding
equipment so everything I've said about
consumption goods creating a basket of
consumption goods we also want to
include in their producer goods so that
just adds to our problems
the quality of data in poorer countries
also tends to be quite poor so this
motivates other ways of trying to figure
out what GDP or standard of living is
like electricity consumption is another
proxy for standard of living and you can
actually estimate this and Henderson
story garden while did this in a paper
called measuring economic growth from
outer space by looking at the lights at
night here's a famous picture this is
from my textbook with Tyler showing
South Korea down here lots of lights
lots of action this is at night lots of
people going on to parties this is North
Korea up here pretty quiet you can
therefore see just by looking at the
lights that North Korea is a much poorer
country than South Korea you can look at
this not just at a point in time but you
can actually see the lights coming on
you can actually see economic growth as
it happens in China for example you see
literally the lights turning on at night
as the country becomes richer so this is
another way of trying to get at some of
these issues so what's the bottom line
well the bottom line is the site despite
some problems PPP adjusted GDP or real
GDP it's a very useful statistic for
comparing countries so we can look at
the total GDP of the United States this
is in 2007 was twelve point nine
trillion dollars the real GDP per capita
was 42.8 you can compare that with China
which had a very large total GDP eight
point four trillion almost as large as
the United States the GDP per capita
however was much much lower India even
lower yet so even though it's imperfect
these real PPP adjusted GDP statistics
are very useful for comparing countries
and for looking at how countries are
growing over time thanks
you