Question

What are the two main difficulties that arise in comparing different countries's GDP?

Short answer

The two main difficulties in comparing different countries' GDP are differences in population size and variations in currency exchange rates. To account for population size, economists use GDP per capita, which divides the total GDP by the country's population to provide a more accurate representation of the standard of living. However, variations in currency exchange rates can also skew comparisons, since GDP is typically measured in a country's domestic currency and needs to be converted to a common currency. This issue is mitigated by using purchasing power parity (PPP) exchange rates, which adjust for price level differences between countries, providing a more consistent basis for comparison.

Step-by-step solution

1. Accounting for differences in population size

When comparing countries' GDP, one main difficulty is accounting for differences in population size. Larger countries tend to have a higher GDP simply because they have more people producing goods and services. Therefore, it's important to consider GDP per capita, which is calculated by dividing the total GDP by the country's population. GDP per capita provides a more accurate representation of the standard of living within each country, as it accounts for differences in population size.

2. Variations in currency exchange rates

Another difficulty in comparing countries' GDP is dealing with variations in currency exchange rates. GDP is usually measured in a country's domestic currency, and comparing these figures directly for various countries requires conversion to a common currency, such as the US dollar or the Euro. However, fluctuating exchange rates can skew GDP comparisons over time, as currency values may change more rapidly than the actual changes in a country's economic output. To mitigate this issue, economists can use purchasing power parity (PPP) exchange rates, which adjust for differences in price levels between countries and provide a more consistent basis for comparison.