Define purchasing power parity (PPP). If we want to compare the standards of living in China and Norway, should we compare GDP in PPP terms or in US$ terms?

Purchasing Power Parity (PPP)

Purchasing power parity is an economic theory that states that the exchange rate between two currencies should be equal to the ratio of the prices of a basket of goods and services in each country. In other words, PPP implies that a unit of currency should have the same purchasing power in all countries, regardless of the exchange rate.

Comparison of China and Norway

To compare the standards of living in China and Norway, we should compare GDP in PPP terms rather than US$ terms. PPP adjusts for differences in the price of goods and services between countries, allowing for a more accurate comparison of real purchasing power and living standards.

Using GDP in US$ terms would not accurately reflect the actual purchasing power of citizens in each country. For example, if a gallon of milk costs $1 in China and $2 in Norway, then a Chinese worker earning $100 could buy 100 gallons of milk, while a Norwegian worker earning the same amount in US$ could only buy 50 gallons. Therefore, comparing GDP in PPP terms provides a more meaningful assessment of living standards.