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PPPs for policy making: a visual guide to using data from the ICP - Chapter 1: The size of the economy and price levels

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Size of the economy

Gross domestic product (GDP) is a measure of economic output within an economy. The ICP follows the expenditure or demand approach to estimating GDP, that is, the sum of the final expenditures on goods and services plus exports less imports of goods and services. This approach allows ICP results to be used in comparisons of the levels of the principal elements of final demand, that is, consumption and investment. Thus, ICP data are appropriate for many different types of economic analysis benefitting policy making, including economic forecasting and poverty analyses.

Internationally comparable estimates of GDP expressed in PPP terms overcome the shortcomings of the alternative approach of using market exchange rate-converted estimates of GDP. The latter reflect not only differences in the volume of output but also differences in national price levels, and thus inflate the size of higher-income economies, where price levels tend to be higher for non-tradable goods, and deflate the size of lower-income economies where prices are generally lower. Furthermore, the volatility of market exchange rates and their decoupling from relative prices may result in fluctuating estimates of GDP. PPP-based estimates effectively neutralize these distortions. PPP-based cross-country comparisons of GDP (figure 1.1) and its expenditure components only reflect differences in economic outputs or volume, as PPPs control for price level differences between economies and account for the relative purchasing power of currencies in their national markets.

The change over time in the volume of output can be tracked by measuring PPP-based GDP at constant prices for a given ICP reference year such as 2017 (figure 1.2).

The International Monetary Fund (IMF) calculates implied PPP conversion factors using the growth in relative GDP deflators (the deflator of a country divided by the deflator of the United States). These conversion factors are used to project PPP-based GDP at the country level (figure 1.3). Furthermore, country group data or aggregates relating to the domestic economy, whether growth rates or ratios, are weighted by PPP-based GDP as a share of world total or country group GDP.