4.2 Comparisons of Living Standards - Comparisons over Space

Question 1

Why is the difference in real GDP per capita growth rates not an accurate indicator?

Answer 1

Differences in real GDP per capita growth rate does not imply similar differences in the real GDP per capita of a country (and hence similar differences in the material SOL) but rather differences in the rate of change of the GDP between the countries.

Question 2

Define purchasing power parity (PPP).

Answer 2

PPP is a theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries.

Question 3

Why is the foreign exchange rate applied to real GDP per capita not accurate in determining economic growth?

Answer 3

• Exchange rates are highly volatile and changes in the exchange rate does not imply similar changes in a country’s economic growth as the exchange rate is affected by various factors (such as the supply and demand in the forex market)
• Exchange rates are more relevant to products traded between countries as they sell for similar prices due to international competition, they are less relevant for domestic goods due to the lack of international export

Question 4

Why is the PPP adjusted exchange rated used when making comparisons of GDP across space?

Answer 4

PPP adjusted exchange rate accounts for differences in the cost of living when comparing material welfare between countries to make comparisons of welfare measurements concerning the purchasing power of incomes made by individuals more accurate.

Question 5

Why must differences in populations be accounted for in making comparisons across space?

Answer 5

Production levels of a country as a whole is heavily affected by a country’s population. However, given that a small country will have a lower total production, it does not necessarily mean that the residents enjoy less material welfare.

Question 6

What are the limitations of PPP adjusted real GDP per capita?

Answer 6

• Difficulties in determining the basket of goods: No two countries can produce the exact same basket of goods and this ultimately affects the accuracy of the comparison + Consumption patens vary from country to country and it is hard to determine the composition of each good in the basket
• Difference in consumption patterns based on context of countries: Individuals in certain countries may consumer more due contextual differences, however, this increased consumption does not translate to a higher material welfare
• Difference in accounting procedures: Not every country uses the same basis for their figures of GNI/GDP as there is no international standard, leading to different variables being measured to different degrees of accuracy + The extent of development of country will affect the accuracy of the calculations as less developed countries may not have the technology or easy access to data
• Omission of non-marketed transactions: Specifically for developing nations, a large proportion of economic activity will take place outside the market due to the lack of an effective mechanism to capture these transactions across the country ultimately leading to GDP figured being underestimated (compared to a developed country)