The Difference Between GDP Nominal And GDP PPP

Here is a rule of thumb to help in grasping the practical differences between GDP Nominal and GDP PPP.

GDP is gross domestic product, the total economic output of a country, i.e., the amount of money a country makes. GDP per capita is the total output divided by the number of people in the population, so you can get a figure of the average output of each person, i.e., the average amount of money each person makes.

The two most common ways to measure GDP per capita are nominal and purchasing power parity (abbreviated PPP). Nominal is an attempt at an absolute measure, a sort of immovable standard that remains the same from country to country. It is the original concept of GDP. In contrast, PPP is an attempt at a relative measure, taking factors of each country into consideration in order to put a number on a person’s standard of living within that country.

Now, that explanation is a good start I suppose, but it is rather vague. That’s where most explanations stop, so let me put it in more concrete terms that will allow you to easily remember the difference.

A rule of thumb for understanding GDP’s PPP and nominal is that PPP is how much of a local good (like real estate, labor, or locally grown produce) a person can buy in their country, and nominal is roughly how much of an internationally traded good (diamonds, DVD players, Snickers bars) a person can buy in their country.

Thus, developing countries tend to have a higher (better) PPP than nominal, while developed countries have higher nominal than PPP. You can get dinner for $10 or a DVD player for $100 in the US, or you can get dinner for $2 or a DVD player for $100 in China. If you compare a Chinese person making $20 a day to an American making $150 a day, the Chinese person is slightly poorer in dinners than the American (1/10 of income versus 1/15), but is a lot poorer in DVD players than the American (5x income versus 2/3 of income). See how that works?

Nominal and PPP are identical in the US, because USD is used as the benchmark. But in all of the most developed countries except the US, the nominal is higher.

Another way to think about this is that, as a country’s citizens get richer and richer, they are more easily able to acquire international goods, but any good that must be provided by others of its own rich citizens, like college education, health care, taxis, etc. is going to get more expensive.

I’m just theorizing on the fly here, but my guess is that the fact that the UK, Japan etc. have higher nominal than PPP as compared to the US indicates that though the US is very rich in absolute dollars and so is able to buy lots of DVD players, it also has a greater income disparity than these countries, so the well off are able to buy more services from U.S. poor.

…which might explain some of the reason why a Big Mac or a hair cut might be cheaper in the US than in the UK, but health care and education more expensive, because the latter two are bought from the rich, whereas in the UK and Japan, the income disparity is narrower, so that even things bought from the poor are more expensive…

It is actually just a coincidence that the developed country that provides the benchmark currency has the lowest level of socialism and thus greatest income disparity among all developed countries, so don’t read too much into the fact that every developed country except the US has a higher nominal than PPP. Since whether PPP is higher or lower depends on the benchmark being used, it is a coincidence that things break down so neatly.

(There are other factors of course. Another important factor for keeping US PPP high compared to other countries is the availability of land compared to most other developed countries, thus keeping the price of both real estate and natural resources lower in the US than in those countries. Note that Canada also has almost the same PPP and nominal.)

Here’s some of the stats (in USD), taken from Wikipedia in the fall of 2009:

US PPP and Nom. 46,800
UK PPP 36,500 Nom. 43,700
Japan PPP 34,000 Nom. 38,000
Sweden PPP 37,200 Nom. 52,800
Canada PPP 38,025 Nom. 39,668
Australia PPP 38,910 Nom. 45,586
N. Zealand PPP 26,707 Nom. 27,259
S. Korea PPP 27,600 Nom. 19,500
Saudi Ar. PPP 23,814 Nom. 18,855
Russia PPP 15,948 Nom. 11,807
Mexico PPP 14,534 Nom. 10,212
Brazil PPP 10,455 Nom. 7737
Dominican R. PPP 8896 Nom. 5176
China PPP 6549 Nom. 3554
Bolivia PPP 4300 Nom. 1700
Vietnam PPP 2793 Nom. 1042
Kenya PPP 1711 Nom. 838
Haiti PPP 1317 Nom. 790
DR Congo PPP 329 Nom. 185

I think this bears my explanation out. A Bolivian can buy almost nothing of international goods and services, but because his countrymen are also poor, he can buy whatever they are able to provide much easier. A Swede is very rich in international money, richer than an American, but their relatively high level of socialism and income equality means they are poorer than an American as far as what they can get in their own country.

(And to put my own little political jab on it, this also seems to show that robust social safety nets a la Sweden do not kill capitalism and the ability to win in the race for the filthy lucre. Sweden is more productive per capita than the US is. Although that’s also because, for reasons I’m not prepared to explain, small rich countries like Sweden are more likely to have higher nominal GDPs compared to huge and lumbering rich countries like the U.S. and the UK.)

-Joe Kern

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If you like this post, you may be interested in these other things on economics I’ve written:

How The Free Market Fails At Health Insurance

What Every Liberal Should Know: Thomas Sowell’s Basic Economics