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The idea behind PPP is that goods and services have a different cost in each country. It works a bit like the basket of goods we use to gauge inflation. You basically take a list of goods and services that the average person would consume and work out how much they would cost in pounds to buy in the UK and then how much in say € they would cost to buy in France. This allows an exchange rate to be calculated that could be different to the actual exchange rate.
The PPP based comparison is therefore fairer. It allows you to compare spending power between two different economies on the same basis.
The official £/€ exchange rate is 1.23. On a basic GDP comparison you would take the Fench GDP, divide it by 1.23 and compare it to the british. However.. if goods in the UK costs a lot more to buy than in france then it is not a fair comparison since the UK would be poorer than the numbers suggest.
The PPP comparison might adjust the rate to closer to 1.1 for instance meaning you only divide french GDP by 1.1 to compare to british therefore making the french economy look bigger in british pounds.
It gets a bit more convoluted and in practice the comparison is never as clean and easy as that. But hopefully this gives the gist.
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April 27th, 2012, 06:19 PM
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