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welfare
Difficulties with PPP comparisons in welfare economics
While using PPP exchange rates for income comparison is an improvement over
using market exchange rates, it is still imperfect, and comparisons using the
PPP method can still be misleading. Comparing standards of living using the PPP
method implicitly assumes that the real value placed on goods is the same in
different countries. In reality, what is considered a luxury in one culture
could be considered a necessity in another. The PPP method does not account for
this. (This is not primarily a flaw in the exchange rate methodology, as
cultural and interpersonal differences in utility functions are a more
fundamental microeconomic problem.)
A PPP exchange rate varies depending on the choice of goods used for the index
(CPI). Hence, it is possible to deliberately or accidentally bias a PPP exchange
rate by the choice of a bundle. Indeed, it may be hard to construct equivalent
representative bundles for the consumption habits of very different societies.
PPP could also have difficulty accounting for differences in quality between
goods in one country and equivalent goods in another, see: consumer price index.
Even if a good PPP is used, GDP per capita is still a measure of the economic
output of the whole economy, not a direct measure of the mean or median person's
quality of life. Other factors such as the standards of homes and schools,
access to public services, the extent of pollution, and strength of consumer
protection laws are hard to quantify and generally not fully reflected in the
GDP. Even a PPP-adjusted measure of GDP per capita must be used with caution,
for all the usual reasons that the GDP figure itself is limited (for instance,
its inability to capture the surplus between subjective value and payment
price).
For example, in 2002, the nominal GDP per capita in Japan was about US$40,000,
while the equivalent PPP into a U.S. goods basket was estimated at $27,000. In
the U.S., GDP per capita was about $36,400 (nominal and real if based on 2002
dollars). This means that the average U.S. citizen could enjoy slightly more
consumption than the average Japanese (vastly more if private saving is removed
from consumption income). However, it does not necessarily follow, that this
implies a "higher standard of living" in the sense of "enjoying life" more; the
U.S. has higher crime rates and less social cohesion than Japan, while Japan has
much less physical space per person and arguably less individual freedom.
Ultimately, the quality of life will depend on subjective judgement and
individual preferences.
While per-capita income does not take into account inequalities in wealth
distribution, neither does the PPP-scaled income.
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