Why is Pakistan's GDP higher than Bangladesh in PPP but lower in Nominal?

Question

Why is Pakistan's GDP higher than Bangladesh in PPP but lower in Nominal?

Kindly explain in layman's terms.

Answer 1

Purchasing power parity (PPP) takes into account the fact that dollar, or whatever currency is used to make the comparison, has different purchasing power in different countries.

For example, if wine costs \$10 to buy a in the U.S., and it costs 8.00€ to buy an identical wine shirt in Germany, if we want to avoid comparing apples to oranges we must first convert the 8.00€ into \$. If the exchange rate was such that the beer in Germany costs \$20.00, but based on law of one price we know that the same products should have (in absence of trade barriers and transportation costs) the same price, so if after exchange rate conversion the identical beer costs \$20 in Germany but only \$10 in US we know that dollar must have weaker buying power in Germany and we can use PPP to adjust it. The PPP is calculated to find the factor at which the purchasing power is the same (hence the name purchasing power parity) and thus PPP here would be 20/10, or 2.

Hence in the above example without PPP comparison the nominal GDP of Germany and US, assuming the beer is the only thing produced, would be \$10 and \$20 dollars. This naive comparison makes it look that Germany produces more output - but that can’t be we know that Germany produces in this example the same one bottle of beer. However, after adjusting for the PPP the PPP adjusted GDP would be exactly equal (as it should since in this example both produce the same output). In more complex examples it is entirely possible that one country has higher nominal GDP but lower GDP at PPP since nominal GDP does not take into account the purchasing power differences between countries.