Question

China is About to Overtake the US to Become World's Largest Economy Figures published by the IMF show that China is set to overtake the US to become the world's largest economy. Purchasing power parity or PPP of China will climb to \(\$ 17.632\) trillion this year, compared with \(\$ 17.416\) trillion for the US. But analysis by IHS points out that China is not expected to rise above the US until 2024 in terms of nominal GDP. If PPP of China becomes greater than that of the U.S. but the GDP of the U.S remains higher, does this comparison of PPP really tell us which country has the higher standard of living? What does the news clip mean by 'nominal GDP'?

Short answer

No, comparing PPP alone does not accurately tell us which country has the higher standard of living. Nominal GDP is the market value of goods/services produced within a country, not adjusted for inflation.

Step-by-step solution

Understand the Concept of PPP

Purchasing Power Parity (PPP) is an economic theory that compares different countries' currencies through a market 'basket of goods' approach. By using PPP rates, economists can make comparisons between the economic productivity and standards of living between countries. So, the statement that China’s PPP will surpass the US means that, in terms of the relative value of currency and goods pricing, China’s economic output is greater.

Explore GDP and Its Types

Gross Domestic Product (GDP) could be nominal or real. Nominal GDP refers to the market value of all finished goods and services made within a country during a specific period. Nominal GDP is not adjusted for inflation, making it often higher when prices rise. Real GDP is adjusted for inflation and provides a more accurate reflection of an economy's size and how it’s growing over time.

Comparing PPP and Nominal GDP for Standard of Living

While PPP provides insights into the relative economic productivity and value between nations, nominal GDP refers to the total market value of goods and services without adjusting for inflation. Even if China’s PPP is higher than the US, it doesn’t necessarily indicate a higher standard of living. Standard of living better correlates with measures that consider population, GDP per capita, and other quality of life metrics.

Implications of the News Clip

The news clip signifies that, while China is catching up with the US in terms of economic output (PPP), the US still holds a higher nominal GDP, indicating higher overall market value. Nominal GDP gives a snapshot of how the economy values goods and services in current prices, crucial for assessing debt and production value.

Key concepts

Purchasing Power Parity (PPP)

Purchasing Power Parity (PPP) is a concept that helps compare the economic health and productivity of different countries using a common standard. Imagine you could buy a basket of goods - say bread, rice, and milk - in both the US and China. PPP adjusts the prices of these items to a comparable rate, despite the different local currencies. Using PPP rates, economists can understand how much goods and services are worth in one country compared to another.
When we hear that China's PPP is set to surpass that of the US, it means the value of goods and services, adjusted for local currency, is higher in China. This shift can show that China's economy is producing more value relative to the cost of living.
However, PPP by itself doesn't necessarily tell us everything about a country's wealth or standard of living. While it's great for comparing the productivity and economic output across countries, it doesn't account for other factors like per capita income or the cost of living.

Nominal GDP

Gross Domestic Product (GDP) is a measure of all the goods and services produced in a country during a certain period. When we talk about Nominal GDP, we are looking at these values in today's current prices without adjusting for inflation.
For example, if the US has a higher Nominal GDP than China, it means that the total value of everything the US produced in dollars is higher this year. This is what the news clip points out about China catching up in PPP but not yet surpassing the US in Nominal GDP.
Nominal GDP is often used to evaluate a country's economic performance in the present day and helps in comparing economic size with others, despite being influenced by price changes over time.
It's essential to understand that a higher Nominal GDP showcases a country's market prowess, reflecting the market value of its goods and services but doesn't alone define the residents' standard of living.

Standard of Living

Standard of living is a broader concept that includes not just economic output but also quality of life aspects. This includes income levels, employment, life expectancy, and access to healthcare and education among others.
When comparing the standard of living between China and the US, it's insufficient to look solely at PPP or Nominal GDP. Even though China's PPP may be higher, it doesn't mean its citizens enjoy a higher standard of living than those in the US.
For a comprehensive comparison, we need to consider GDP per capita, which divides the country's GDP by its population. Other factors like inflation, cost of living, and social services are also crucial.
In essence, while China’s rising PPP signals more significant economic output, the US's higher Nominal GDP and quality of life standards suggest its residents may still enjoy a better standard of living.