Definition: Purchasing power parity (PPP) allows you to compare the standard of living between countries by taking into account the impact of their exchange rates. This is best illustrated using an example.
Using the official exchange rate, China's 2006 GDP was $2.527 trillion compared to $13 trillion for the U.S. That means that, for each of the 1.4 billion people living in China, the GDP per capita would be $1,943, about the same standard of living as some of the poorest countries in the world: Uganda or Burma.
However, the cost of living in China is lower than in the U.S. because their currency is held at a rate to keep it cheaper than the dollar. As a result, it is cheaper to produce goods, which also makes consumer items cheaper to buy. Therefore, it is not really fair to compare China's production in dollar terms without taking its cheaper currency into account.
Purchasing power parity solves that problem. China's GDP, using PPP, is $10.2 trillion, which makes it the world's third largest economy, after the U.S. and the EU. That makes China's GDP per capita is $7,800 per person, the same as Ukraine. (Source: CIA Factbook)
Also Known As: PPP
Examples: The CIA provides GDP estimates on both an official exchange rate and a purchasing power parity basis.
