Question: What's the Best Way to Compare GDP by Country?
Answer: There are three ways to compare the economic output, or Gross Domestic Product (GDP), between countries. To determine which one to use, you've first got to decide what your purpose is. Second, you've got to take into account the effect of exchange rates and population. Here's a summary of the three ways, how they are calculated, and why you would use them.
Official Exchange Rate
The most commonly agreed-upon measure is the Official Exchange Rate (OER). This gives the economic output within the country's own currency. It can be used to give you an idea of how much the country can use its economic power to purchase on the international markets. For example, China maintains a fixed exchange rate for the yuan, its national currency. China pegs the yuan to always be lower than the dollar. As a result, China's labor and manufacturing costs are less. This makes the prices of China's exports less expensive, making anything "Made in China" more competitive in the global marketplace.
As a result, the OER method will result in a lower figure for China's economic output -- in 2012, it was just under $8.26 trillion. The good news for China's residents is, it also makes their cost of living lower. For example, a Big Mac only cost $2.57 in China in 2011, while it costs $4.37 in the U.S. (Source: The Economist, Big Mac Index)
Use the OER method when you want to compare two emerging market countries to each other, or two developed economies to each other. You can also use it to compare the country's economic output over time, as long as its exchange rate hasn't changed dramatically.
The CIA provides the OER method. It lists every country and its GDP by alphabetical order. That's helpful when you already know what country you want to investigate, and want to be able to find it easily.
Purchasing Power Parity
There are two disadvantages to using the OER method. The first, is that exchange rates change over time. The second is that they can be manipulated. Therefore, the OER method can lead you to draw misleading conclusions. Purchasing power parity (PPP) allows you to make more accurate comparisons of the economies of two countries. It's calculated by determining what each item purchased in a country would cost if it were sold in the U.S. These are then added up for all the final goods and services produced in that country for that given year.
GDP using PPP takes some judgement to measure accurately. Everything produced in a country must be assigned a dollar value. That can be especially difficult if it's something that's not produced or even sold in the U.S., such as a cart pulled by oxen. However, the PPP method is most important when comparing emerging market countries to developed market countries. The PPP method give a more accurate reflection of the power of China's economy. In 2012, China's economic output using the PPP method was $12.3 trillion. This was $4 trillion more than when the OER method was used.
Here's the CIA World Factbook's GDP by Country using PPP. Since this method takes into account the effect of exchange rates, it is able to rank all the countries in order of GDP. For 2012, it shows that the European Union is the world's largest economy, while the U.S. is second. Two emerging market countries, China and India, are #3 and #4. The next two economies are Japan (#5) and Germany (#6).