GDP for different countries is usually measured in a common currency – normally we use the US dollar. But there are two problems in using exchange rates to measure GDP
- Exchange rates can be volatile from month to month and from year to year. For example a large depreciation in the value of the Argentinean peso against the US dollar might imply that Argentinean living standards have fallen even though their economy might actually be growing quite quickly
- Exchange rates are more relevant to products that are traded between countries rather than non-traded products. Manufactured goods tend to sell for similar prices in most parts of the world – this is because international competition tends to reduce the differentials in prices for similar products. Non-traded service such as domestic cleaners, haircuts and academic tutors tend to have bigger differences in prices.
Calculations of GDP based on market exchange rates tend to over-estimate the cost of living in poorer developing countries.
This is called the Balassa-Samuelson effect.
