Ppp Model

PPP Makes India Third Largest Economy of World

According to the World Bank, India is third largest economy (USD6,774 billion) of the world after the US and China in terms of purchasing power parity (PPP). But if the countries are ranked in terms of gross domestic product (GDP) compared on the basis of nominal exchange rate, India is ranked 10 (USD1,876 million). The difference between the two approaches exists because the former takes into account the relative costs and the inflation rates of the countries. The nominal exchange rate approach takes into account the market exchange rate determined by the demand and supply of foreign currency.
 
To illustrate, if a standard burger of McDonald costs USD2.0 in the US, in terms of market determined nominal exchange rate, it should cost INR120 in India if the market exchange rate is 1USD = INR60. But if in reality, similar burger costs INR80 in India, then the exchange rate on the basis of PPP would be 1USD = INR40. In gist, the PPP exchange rate is the rate at which the currency of one country would have to be converted into that of another country to buy the same amount of goods and services in each country. 
 
The price of burger in terms of PPP approach is less than that of market exchange rate approach because cost of production in India is less than that of US due to low labour cost. Additionally, inflation rate is also adjusted from nominal price of burger. Because wages are lower and inflation is high in developing countries, there is a large gap between market and PPP based rates in developing countries while in advanced economies, they tend to be much closer.
However, comparison of exact GDP on the basis of PPP is not possible as comparing the price of each good and service in each country across the world would be nearly impossible. To facilitate price comparisons across countries, the International Comparisons Program (ICP) was established by the United Nations and the University of Pennsylvania in...