Equilibrium / Hilary Ellison

Gross domestic product allows you to compare the economies of the countries of the world. It measures everything that is produced by people in a given country, whether they are citizens of that country or not.

The International Monetary Fund has measured the GDP of all countries in the world. As of 2018, the top 10 countries by GDP are:
United States: $20.4 trillion

China: $14.0 trillion

Japan: $5.1 trillion

Germany: $4.2 trillion

UK: $2.9 trillion

France: $2.9 trillion

India: $2.8 trillion Italy: $2.1 trillion

Brazil: $2.1 trillion

Canada: $1.7 trillion

Together, these countries generate 67% of the world's $87.5 trillion GDP.

The European Union is a trade and monetary union, not a country. But if that were the case, it would be the second largest. Its GDP is $19.6 trillion.

If you combine the three leading economies - the US, the EU and China - their GDP would be 54 trillion dollars. This is 62% of the total production in the world. Their GDP shows that what they do has a huge impact on the global economy.

Three ways to measure GDP by country

There are three ways to compare GDP between countries. The one you use depends on your goal and how it will be affected by exchange rates and population.

Here is a summary of the three ways how they are calculated and when you would use them.

Official exchange rate

The IMF uses the most commonly used measure, the official exchange rate. This rate is set by the government or the central bank of the country. It tells you how much the bank will give you in exchange for one unit of your country's currency.

The official exchange rate must be a fixed exchange rate. Values ​​do not change at the whim of the market. Most central banks fix their currencies either to the US dollar or to the currencies of their major trading partners.

For example, China has traditionally maintained a fixed exchange rate for the yuan, its national currency. China has pegged the yuan to a 2% range against a basket of currencies that includes the US dollar. This allows China to control its labor and production costs. This makes Chinese export prices less expensive, so anything made in China is more competitive in the global market.

Because China has a low exchange rate, the OER method gives a low figure for China's economic output.

The good news for Chinese people is that it also makes the cost of living lower. In June 2018, a Big Mac cost only $3.10 in China, while it cost $5.51 in the US. The Economist magazine created the Big Mac Index to determine where currencies are up to par in purchasing power parity. The index says the yuan was undervalued by 44%.

Use the OER method when you want to compare two emerging markets or two advanced economies. You can also use it to compare a country's economic output over time, as long as its exchange rate hasn't changed drastically.

In addition to the IMF, the OER method is used by the CIA World Factbook. It lists all countries and their GDP in alphabetical order. This is convenient when you already know which country you want to explore.

Purchasing power parity

Purchasing power parity allows for more accurate comparisons between the economies of the two countries. It compensates for changes in exchange rates over time. It also takes into account government manipulation of exchange rates.

PPP GDP is calculated by determining how much each good bought in a country would cost if it were sold in the US. These costs are then added together to obtain the total volume of goods and services produced in a given country in a given year.

PPP can be very subjective. Everything that is produced in the country must have the value of the US dollar. This can be especially tricky if it's something that isn't made or even sold in the US, like an oxcart.

The PPP method is most important when comparing emerging market countries with developed market countries. The PPP method gives a more accurate reflection of the strength of the Chinese economy.

The IMF calculates GDP by country using PPPs.

In 2018, China's PPP economic output was $25.2 trillion. Using the PPP method, China will replace the US as the world's largest economy.

10 largest economies in the world using PPP
(in trillions of US dollars)

GDP per capita

GDP per capita is a good way to compare the output of a country from the point of view of its inhabitants. It divides the output of a country's economy by its population. You can use GDP per capita to compare any country with another.

The IMF calculates GDP per capita based on the OER method. Here are the top 10 countries as of 2018:
Luxembourg: $114,234

Switzerland: $82,950

Macau: $82,387 Norway: $81,694

Ireland: $76,098

Iceland: $74,278

Qatar: $70,779

Singapore: $64,041: $62,605

Denmark: $60,692

China and the EU are not even on this list. In China, GDP per capita is $9,608, while in the EU it is $43,074. Both regions have large regions with low GDP. The population of China is 1.39 billion people.

The situation looks different when using PPP. For example, China's per capita GDP rises to $18,200 when the exchange rate impact is taken into account. The standard of living in the US is much higher than in China, at $59,800 per capita. This is because there are far fewer people there.