Two economic measures: GDP and GNI per capita

Overview

Purchasing power parity and weaknesses of PPP conversion itself.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What does gross domestic product measure, and how is it expressed per head?

   Model answer

   GDP is the total value of all goods and services produced within a country's borders in a year, regardless of who owns the firms producing them. GDP per capita is that total divided by the country's population, normally converted into US dollars so that countries can be compared. It is published annually by bodies such as the World Bank, the IMF and the UN.

2. 2

   How does GNI differ from GDP, and why can the difference matter in an LEDC?

   Model answer

   GNI (gross national income, formerly GNP) is GDP plus net income from abroad: it adds income earned by the country's residents overseas, such as wages, remittances, interest and profits, and subtracts income earned inside the country by foreign owners and sent out. GDP measures production in a place; GNI measures income belonging to its people. The gap matters where foreign TNCs own much of the mining or manufacturing sector: production counts in GDP, but repatriated profits leave, so GDP overstates the income actually available. Conversely, a country with many migrant workers abroad may have GNI above GDP because of remittances flowing in.

3. 3

   Why are GNI figures usually converted into US dollars?

   Model answer

   Each country measures output in its own currency, so the raw figures cannot be compared. Converting everything into a single currency, conventionally the US dollar, puts them on one scale and allows ranking, mapping and grouping into income bands. The conversion is where the difficulty starts, because the choice between market exchange rates and purchasing power parity changes the answer substantially.

4. 4

   What is purchasing power parity, and how does GNI per capita at PPP differ from GNI per capita at market exchange rates?

   Model answer

   At market rates, a country's GNI is converted using the exchange rate at which its currency actually trades. At purchasing power parity it is converted using the amount of local currency needed to buy the same basket of goods and services that a US dollar buys in the United States. The two give different answers because many goods and services are not traded internationally, so exchange rates do not reflect what money buys locally. PPP figures are a measure of real purchasing power; market-rate figures are a measure of internationally comparable spending power. They are different quantities and should never be quoted interchangeably.

5. 5

   Which figure is normally higher for an LEDC, GNI per capita at PPP or at market rates, and why?

   Model answer

   The PPP figure is normally higher, often two to four times higher. Non-traded goods and services such as housing, local food, transport, haircuts and domestic labour are much cheaper in low-income countries because wages there are low, so a dollar converted at the market rate buys far more than it would in the USA. India illustrates the scale of the difference: GNI per capita of very roughly $2,500 at market rates corresponds to something in the region of $9,000 at PPP. In high-cost MEDCs such as Switzerland or Norway the adjustment can work the other way, lowering the figure.

6. 6

   What happens to the apparent development gap when you switch from market exchange rates to PPP?

   Model answer

   It narrows, because LEDC incomes are revised upwards relative to MEDC incomes. The gap does not disappear: PPP corrects for price levels, not for the real difference in the volume of goods and services people can consume, so the richest countries still have many times the purchasing power of the poorest. Switching measures changes the size of the gap you report, which is why the basis must always be stated.

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