What this lesson teaches
I can compare living standards over time and between countries, and say where the comparison is weak.
Syllabus 8843, 3.2.1(d). Standard of Living and Macroeconomics Indicators: Comparison of living standards over time and over space (between economies)
Make a guess
Income per person is US$30,000 in country A and US$20,000 in country B. But a basket of goods costs US$15,000 in A and US$8,000 in B. Where can people buy more?
- Country A, because its income is 50% higher.
- Neither, because the two incomes cannot be compared.
- Country B, where income buys 2.5 baskets against 2.
Show the answer
Country B, where income buys 2.5 baskets against 2.
Purchasing power parity adjusts for prices. Lower prices in B mean its income buys more goods than A's.
Compare countries using PPP-adjusted per capita figures, then check distribution and non-material factors.
Different countries use different currencies and have different price levels. Converting income at market exchange rates can mislead, because a dollar buys much more in some countries than in others.
Purchasing power parity (PPP) adjusts for these price differences, showing what incomes can actually buy in each country.
Use PPP-adjusted GDP or GNI per capita for comparisons, then look at inequality, and at non-material factors such as health, education and the environment.
Data quality also matters: some countries have large informal sectors that official statistics miss.
- PPP
- Adjusts for price differences between countries.
- Also check
- Inequality, informal sector, non-material factors.
Worked example: The higher income buys less
At market exchange rates, income per person is US$30,000 in country A and US$20,000 in country B. But the same basket of goods costs US$15,000 in A and US$8,000 in B.
- At market rates, A looks 50% richer.
- In A, income buys 30,000 / 15,000 = 2 baskets. In B, 20,000 / 8,000 = 2.5 baskets.
- Adjusted for prices, people in B can buy more.
- Distribution and non-material factors still need checking before a full judgement.
Watch out for this
The country with the higher income in US dollars always has the higher material living standard.
Prices differ between countries. PPP adjusts for what incomes can actually buy.
Check your understanding
Why use PPP when comparing incomes between countries?
- PPP converts each income into US dollars at the market exchange rate.
- PPP shows how income is shared within each country, which GDP alone misses.
- The same amount of money buys different amounts in different countries.
Show the answer
The same amount of money buys different amounts in different countries.
Right. PPP adjusts for differences in price levels.