# How Real GDP Is Used [ccc]

Parkin p. 560

ESTIMATES OF REAL GDP AND THE REAL GDP growth rate are used for many purposes. But the three main uses are to:

• Make international comparisons of CDP
• Assess changes in economic welfare over time
• Determine the current phase of the business cycle
• PPP (Purchasing Power Parity) Statistics of OECD [AJK]

## International Comparisons of GDP

To make international comparisons, the real CDP of one country must be converted into the same currency units as the real CDP of the other country. For example, in 1990 the real CDP of China was 1,769 billion yuan. In that year, \$1 U.S. was worth 4.78 yuan. If we use this exchange rate to convert China's real CDP into U.S. dollars, we get a value of \$370 billion. The population of China in 1990 was 1, 139 million, so according to these estimates, real CDP per person in China in 1990 was \$325. In comparison, U.S. real CDP in 1990 was \$5,546 billion and the population of the United States was 250 million, so real CDP per person in the United States in 1990 was \$22,200, some 68 times larger than real CDP per person in China.

This comparison of China and the United States makes China look extremely poor, and the official statistics published by the International Monetary Fund (IMF) and the World Bank give this impression. But data on China's real CDP in the Penn World Table (PWT) compiled by Robert Summers and Alan Heston, economists at the University of Pennsylvania, tell a remarkably different story. The difference arises from the prices used. The official statistics use Chinese prices converted to U.S. dollars at the market exchange rate. But these prices are misleading. Some goods that are expensive in the United States cost very little in China. If the prices of these items are converted into U.S. dollars, these items get a small weight in China's real CDP. If, instead, all the goods and services are valued at the prices prevailing in the United States, then a better comparison can be made. Such a comparison uses prices called purchasing power parity prices.

The result of this correction to the prices at which China's production is valued changes the picture by an incredible amount. Instead of real CDP per person in 1990 being \$325, it was perhaps as much as \$2,000-more than 6 times the official estimate. Figure 23.7 shows this amazing difference.

The World Bank and International Monetary Fund data tell us that China is a poor developing country. The Penn World Table data tell us that China has become a middle-income country. The Penn World Table data also tell us that China's real CDP exceeds Germany's, and China's economy is the third largest in the world after that in the United States and Japan.

Despite large differences in estimates of the level of China's real GDP, there is much less doubt about its growth rate. The economy of China is expanding at an extraordinary rate and it is for this reason that most businesses are paying a great deal of attention to the prospects of expanding their activities in China and the other Asian economies.

The alternative measures of China's real CDP are to some degree unreliable, and the truth is not known. But even if it were, there would still be problems in comparing the United States and China. These problems also affect comparisons in a single country over time. They arise because real CDP is an imperfect measure of economic welfare.

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