### Learning Objectives

By the end of this section, you will be able to:

• Explain how we can use GDP to compare the economic welfare of different nations
• Calculate the conversion of GDP to a common currency by using exchange rates
• Calculate GDP per capita using population data

It is common to use GDP as a measure of economic welfare or standard of living in a nation. When comparing the GDP of different nations for this purpose, two issues immediately arise. First, we measure a country’s GDP in its own currency: the United States uses the U.S. dollar; Canada, the Canadian dollar; most countries of Western Europe, the euro; Japan, the yen; Mexico, the peso; and so on. Thus, comparing GDP between two countries requires converting to a common currency. A second issue is that countries have very different numbers of people. For instance, the United States has a much larger economy than Mexico or Canada, but it also has almost three times as many people as Mexico and nine times as many people as Canada. Thus, if we are trying to compare standards of living across countries, we need to divide GDP by population.

# Converting Currencies with Exchange Rates

To compare the GDP of countries with different currencies, it is necessary to convert to a “common denominator” using an , which is the value of one currency in terms of another currency. We express exchange rates either as the units of country A’s currency that need to be traded for a single unit of country B’s currency (for example, Japanese yen per British pound), or as the inverse (for example, British pounds per Japanese yen). We can use two types of exchange rates for this purpose, market exchange rates and purchasing power parity (PPP) equivalent exchange rates. Market exchange rates vary on a day-to-day basis depending on supply and demand in foreign exchange markets. PPP-equivalent exchange rates provide a longer run measure of the exchange rate. For this reason, economists typically use PPP-equivalent exchange rates for GDP cross country comparisons. We will discuss exchange rates in more detail in Exchange Rates and International Capital Flows. The following Work It Out feature explains how to convert GDP to a common currency.

### Converting GDP to a Common Currency

Using the exchange rate to convert GDP from one currency to another is straightforward. Say that the task is to compare Brazil’s GDP in 2013 of 4.8 trillion reals with the U.S. GDP of $16.6 trillion for the same year. Step 1. Determine the exchange rate for the specified year. In 2013, the exchange rate was 2.230 reals =$1. (These numbers are realistic, but rounded off to simplify the calculations.)

Step 2. Convert Brazil’s GDP into U.S. dollars:

$\begin{array}{rcl}\text{Brazil's GDP in \ U.S.}& \text{ = }& \frac{\text{Brazil's GDP in reals}}{\text{Exchange rate (reals/\ U.S.)}}\\ & \text{ = }& \frac{\text{4.8 trillion reals}}{\text{2.230 reals per \ U.S.}}\\ & \text{ = }& \text{\2.2 trillion}\end{array}$

## Summary

Since we measure GDP in a country’s currency, in order to compare different countries’ GDPs, we need to convert them to a common currency. One way to do that is with the exchange rate, which is the price of one country’s currency in terms of another. Once we express GDPs in a common currency, we can compare each country’s GDP per capita by dividing GDP by population. Countries with large populations often have large GDPs, but GDP alone can be a misleading indicator of a nation’s wealth. A better measure is GDP per capita.

## Glossary

exchange rate
the price of one currency in terms of another currency
GDP per capita
GDP divided by the population