When I teach Development Economics classes I ask my students, How is GDP calculated?
There are a lot of difficulties in comparing countries GDP. For example, if two people one in the US and one in India produce the same shoe, but the shoe costs $40 in the US and $10 in India, then that shoe would add more to US GDP than India. However, with GDP we want to figure out the size of all goods produced in the economy, so the US and Indian shoes should count the same, so we put the Indian shoe in US prices.
Anyone who has been to a developing country knows that often most things are cheaper. So to calculate GDP the World Bank or other organizations try to put that country’s production in US prices. That is they adjust GDP for purchasing power parity, PPP.
But how do they calculate the differences in prices for all these goods?
Apparently the World Bank is still working on its PPP, as Nancy Birdsall highlights in the Center for Global Development Blog. The World Bank had been using extrapolation from 1993 prices, but now that they have taken a new price survey the estimates of Indian and Chinese PPP adjusted GDP have fallen nearly 40% !
So how is GDP calculated? Very carefully, but perhaps not enough.