Chapter 19. The Macroeconomic Perspective

# 19.4 Comparing GDP among Countries

### Learning Objectives

By the end of this section, you will be able to:
• Explain how GDP can be used to compare the economic welfare of different nations
• Calculate the conversion of GDP to a common currency by using exchange rates
• Calculate GDP per capita using population data

It is common to use GDP as a measure of economic welfare or standard of living in a nation. When comparing the GDP of different nations for this purpose, two issues immediately arise. First, the GDP of a country is measured in its own currency: the United States uses the U.S. dollar; Canada, the Canadian dollar; most countries of Western Europe, the euro; Japan, the yen; Mexico, the peso; and so on. Thus, comparing GDP between two countries requires converting to a common currency. A second issue is that countries have very different numbers of people. For instance, the United States has a much larger economy than Mexico or Canada, but it also has roughly three times as many people as Mexico and nine times as many people as Canada. So, if we are trying to compare standards of living across countries, we need to divide GDP by population.

# Converting Currencies with Exchange Rates

To compare the GDP of countries with different currencies, it is necessary to convert to a “common denominator” using an exchange rate, which is the value of one currency in terms of another currency. Exchange rates are expressed either as the units of country A’s currency that need to be traded for a single unit of country B’s currency (for example, Japanese yen per British pound), or as the inverse (for example, British pounds per Japanese yen). Two types of exchange rates can be used for this purpose, market exchange rates and purchasing power parity (PPP) equivalent exchange rates. Market exchange rates vary on a day-to-day basis depending on supply and demand in foreign exchange markets. PPP-equivalent exchange rates provide a longer run measure of the exchange rate. For this reason, PPP-equivalent exchange rates are typically used for cross country comparisons of GDP. Exchange rates will be discussed in more detail in Exchange Rates and International Capital Flows. The following Work It Out feature explains how to convert GDP to a common currency.

### Converting GDP to a Common Currency

Using the exchange rate to convert GDP from one currency to another is straightforward. Say that the task is to compare Brazil’s GDP in 2013 of 4.8 trillion reals with the U.S. GDP of $16.6 trillion for the same year. Step 1. Determine the exchange rate for the specified year. In 2013, the exchange rate was 2.230 reals =$1. (These numbers are realistic, but rounded off to simplify the calculations.)

Step 2. Convert Brazil’s GDP into U.S. dollars: $\begin{array}{r @{{}={}} l}Brazil's\;GDP\;in\;\\;U.S. & \frac{Brazil's\;GDP\;in\;reals}{Exchange\;rate\;(reals/\\;U.S.)} \\[1em] & \frac{4.8\;trillion\;reals}{2.230\;reals\;per\;\\;U.S.} \\[1em] & \2.2\;trillion \end{array}$

# Key Concepts and Summary

Since GDP is measured in a country’s currency, in order to compare different countries’ GDPs, we need to convert them to a common currency. One way to do that is with the exchange rate, which is the price of one country’s currency in terms of another. Once GDPs are expressed in a common currency, we can compare each country’s GDP per capita by dividing GDP by population. Countries with large populations often have large GDPs, but GDP alone can be a misleading indicator of the wealth of a nation. A better measure is GDP per capita.

### Self-Check Questions

1. Is it possible for GDP to rise while at the same time per capita GDP is falling? Is it possible for GDP to fall while per capita GDP is rising?
2. The Central African Republic has a GDP of 1,107,689 million CFA francs and a population of 4.862 million. The exchange rate is 284.681CFA francs per dollar. Calculate the GDP per capita of Central African Republic.

### Review Questions

What are the two main difficulties that arise in comparing the GDP of different countries?

### Critical Thinking Questions

1. Cross country comparisons of GDP per capita typically use purchasing power parity equivalent exchange rates, which are a measure of the long run equilibrium value of an exchange rate. In fact, we used PPP equivalent exchange rates in this module. Why could using market exchange rates, which sometimes change dramatically in a short period of time, be misleading?
2. Why might per capita GDP be only an imperfect measure of a country’s standard of living?

### Problems

1. Ethiopia has a GDP of $8 billion (measured in U.S. dollars) and a population of 55 million. Costa Rica has a GDP of$9 billion (measured in U.S. dollars) and a population of 4 million. Calculate the per capita GDP for each country and identify which one is higher.
2. In 1980, Denmark had a GDP of $70 billion (measured in U.S. dollars) and a population of 5.1 million. In 2000, Denmark had a GDP of$160 billion (measured in U.S. dollars) and a population of 5.3 million. By what percentage did Denmark’s GDP per capita rise between 1980 and 2000?
3. The Czech Republic has a GDP of 1,800 billion koruny. The exchange rate is 20 koruny/U.S. dollar. The Czech population is 20 million. What is the GDP per capita of the Czech Republic expressed in U.S. dollars?

## Glossary

exchange rate
the price of one currency in terms of another currency
GDP per capita
GDP divided by the population

### Solutions 