Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Measuring Living Standards with GDP and Other Methods

Perhaps the main reason macroeconomists are interested in GDP is that summarising the total amount of income in an economy in a year gives a good indication of living standards in that country. But wait a minute! China has a very large GDP, but living standards for the average person aren’t that great. What about the fact that a £10,000 annual salary in the UK can’t buy you as much as the same amount of money in Thailand?

Don’t worry. Macroeconomists have the same concerns! In this section we look at how GDP can be used to reflect living standards in a country, but we also consider some other indicators that might do a better job of reflecting living standards than using GDP alone.

Using GDP per capita: How much cake per person?

If you think about real GDP as the total size of the cake, China has a truly massive cake: to be precise, more than $9 trillion worth of Victoria sponge! Even compared with a rich country such as the UK, this figure is huge (the UK’s GDP is around $2.5 trillion). Why, then, are living standards in the UK so much higher than in China?

As you may have guessed, the total size of the cake is less important than how much cake each person gets: the size of each piece. To find out the average living standard in the UK, you need to divide the UK’s GDP by the number of people in the UK. Then you find that on average every person in the UK has an income of around $40,000, while in China average income is around $7,000. These figures are known as the UK and China’s respective GDP per capita. These are calculated using

market exchange rates between the US dollar and the local currency, but market exchange rates don’t reflect the real relative purchasing power.


Finding a fairer comparison: Purchasing power parity (PPP)

If the UK’s GDP per capita is $40,000 and China’s is $7,000, does that mean living standards are on average around six times higher in the UK than in China? No, because per capita GDP doesn’t take into account the fact that the cost of living in China is less than in the UK. To adjust for the different purchasing power of money in different countries, economists calculate a country’s GDP per capita at purchasing power parity (PPP). This basically allows them to compare the amount of goods you can buy with your (average) income in different countries. Now the difference between the UK and China is much less stark.

The UK’s GDP per capita (PPP) is around $36,000 while China’s is around $12,000. So, when you adjust for the purchasing power of money in the two countries, UK average incomes are only three times more than average incomes in China. So, although people in the UK have on average a higher standard of living than people in China, the difference is much less when you take the different purchasing power of money into account.