Purchasing power parity (PPP) income

The Purchasing Power Parity (PPP) calculation is used to compare the real incomes of people in different countries. It takes into account two things: 1) how much people make and 2) what prices they face in their country.

Consider the example below. The GDP per capita in Australia was about 56,300 dollars in 2015. In the U.S. it was about 56,100 dollars. According to that measure, incomes in Ausralia are higher than in the U.S.

In the second chart we show the PPP income in the two countries. The PPP income in Australia is 44,000 dollars and the PPP income in the U.S. is about 53,000 dollars. According to that measure, incomes in the U.S. are higher than in Australia.

The difference between the two measures arises because Australia is a much more expensive country than the U.S. The Australians earn a lot of money but they also pay high prices. The Americans earn less but they also pay lower prices.
The PPP calculates the incomes as if prices in both countries were the same. In fact, the prices that are used to calculate PPP incomes in different countries are the U.S. prices. Then, the comparison is:

"What can people buy in different countries if they all earn dollars and pay U.S. prices."

Because of that, the U.S. income and the U.S. PPP income are the same when expressed in current dollars. In contrast, in countries where prices are higher than in the U.S., the PPP income will be lower than the income expressed in dollars. In countries where prices are lower than in the U.S., the PPP income will be higher than the income expressed in dollars.


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