Real National Income per Person Tracks Material Living Standards, but It Is Not the Same as Welfare.
Definition
Purchasing power parity: an exchange rate that equalises the cost of a representative basket of goods and services between countries, used to make valid international comparisons of income and living standards.
- Real GDP per capita is the main measure used to assess living standards over time.
- Using real rather than nominal figures removes the effect of inflation, so a rise reflects more output per person and not just higher prices.
- A sustained rise in real income per head normally signals improving material living standards.
Note
- Real national income per capita adjusts for both inflation and population, so it is the fairest single guide to living standards over time.
- Even so, it measures output per person, not how that output is shared or how people actually live.
National Income Data Leave out Much of What Determines Living Standards.
- GDP excludes non-marketed output, such as unpaid household work and voluntary work.
- It misses the informal or black economy, so recorded output understates true activity.
- It ignores the distribution of income, so a higher average can hide rising inequality.
- It takes no account of negative externalities such as pollution, the value of leisure, or non-material aspects of welfare.
Example
- Real GDP per head can rise while pollution, working hours and inequality all worsen.
- So faster growth does not guarantee that most people feel better off.
Comparing Living Standards Between Countries Means Adjusting for Population and Price Differences.
- Between countries, living standards are compared using real GDP per capita.
- Because populations differ, total national income is converted to a per-head figure.
- Purchasing power parity (PPP) exchange rates, not market exchange rates, are used to convert the figures because price levels differ.
Note
- Market exchange rates ignore differences in the cost of living between countries.
- PPP exchange rates adjust for what a given income can actually buy, giving a valid comparison of real living standards.
PPP Matters Because the Same Income Buys Different Amounts in Different Countries.
- A given income buys more where local prices are low, so comparisons at market exchange rates overstate the gap between rich and poorer countries.
- PPP exchange rates correct for these cost-of-living differences, giving a fairer comparison of real incomes.
Example
- Converted at market exchange rates, a low-price economy looks poorer than it really is.
- Worked example: at market exchange rates India's GDP per capita is roughly 2,500 US dollars, but measured at PPP it is around 9,000 to 10,000 US dollars, because rents, food and services cost far less there.
- The PPP figure is closer to what residents can actually buy, so it gives the fairer comparison of living standards.
International Comparisons Stay Useful but Imperfect.
- Data reliability and coverage vary between countries, especially where the informal economy is large.
- Differences in income distribution and in non-material factors mean equal averages can mask very different lives.
- So comparisons should be read with care and alongside wider welfare indicators such as the Human Development Index.
Common Mistake
- Do not treat higher real GDP per capita as automatically higher welfare.
- Do not compare national income across countries at market exchange rates; adjust for PPP first.
Exam technique
- For changes over time, use real GDP per capita and comment on what the data omit.
- For comparisons between countries, adjust for population, use PPP exchange rates, then note the limitations of the data.
Self review
- Why are real, not nominal, figures used to track living standards over time?
- Name three things national income data leave out.
- Why must national income be converted to a per-head figure when comparing countries?
- Why are PPP exchange rates preferred to market exchange rates for international comparisons?
