Question

How does PPP solve the exchange-rate problems when comparing GDP across countries.

Answer 1

To compare GDP across countries it's necessary to convert to a common denominator using exchange rate(value of one currency in terms of the other). However, exchange rate varies on a day to day basis depending on the demand supply in FOREX market. But PPP helps to make more accurate comparison of GDP across countries. GDP using PPP is determined by calculating what each item purchased in a country would cost if it were sold in the USA. Then this cost are added up to get the GDP of that country in that given year. Thus PPP compensates for the exchange rate changes over time and allows to make more accurate comparison of GDP across countries.