Title is self-explanatory.
It’s probably really simple, but for some reason I’ve never been able to understand it. Much thanks in advance!
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“Nominal” GDP uses exchange rates to compare GDP.
Imagine the GDP per capita of the US is $50,000 and the GDP of China ¥50,000.
If the exchange rate is $1 = ¥10 then we can say the GDP/capita of China is $5,000 in nominal terms (or the GDP/capital of the US is ¥500,000).
However if we want to answer a question like “what are people’s living standards like?” about a country there’s a complication. (Well, a number of complications, but one that’s relevant here.) If you’ve ever been on holiday to another country (or even another part of the same country!) and gone “boy, food is really cheap here!” or “wow, things are expensive here!” you’ve noticed the problem.
In nominal terms the prices of things vary in different countries. *In general* things tend to be cheaper in poorer countries. Services tend to be cheaper in the US than comparable rich countries because of an unusually large pool of particularly low-paid labour.
So if you compared what you can buy for $5,000 in China it will be more than what you get for $5,000 in the US. The “purchasing power” of your money is greater than you’d expect.
Thus we have purchasing power parity, or PPP. There may be exceptions but I’ve only ever seen this in US dollar terms. The way this is calculated is a lot like how inflation is calculated. You take a ‘basket of goods’ in one country, and compare the nominal cost to the same ‘basket of goods’ in another.
So let’s say our basket of goods costs $5,000 in the US. On a nominal basis we’d expect it to cost ¥50,000 (the exchange rate is ¥10 = $1). However we discover it only costs ¥25,000. That means the purchasing power exchange rate is actually ¥5 = $1.
Putting all this together, we can compare out nominal and PPP GDP/capita:
Nominal = 50,000 / 10 = $5,000
PPP = 50,000 / 5 = $10,000
The PPP value generally gives you a better of people’s living standards in a country, and what can be done domestically with that country’s GDP (eg. to pick a current example, if you’re comparing military spending in Russia and the US, PPP is a better comparison than nominal (not *good* but better).
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