For the purposes of the ICP, countries report final expenditure on gross domestic product (GDP) broken down into descending levels of aggregation according to a common classification of which the lowest level is the basic heading level. See Final expenditures.
A basic heading is defined as the lowest level of final expenditure for which explicit expenditures can be estimated. In theory, it should cover a group of similar well-defined goods or services. But in practice, an actual basic heading can include a broader range of products than is theoretically desirable.
Basic headings are central to ICP comparisons. It is at the level of the basic heading that expenditures are defined, products are selected for pricing, prices are collected and edited, and PPPs are first calculated and averaged.
PPPs are price relatives. In their simplest form they show the ratio of prices in national currencies of the same precisely defined product in different countries. For example, if the price of a kilo of oranges of a specified quality is 45 rupees in country A and 3 dollars in country B, the PPP for such oranges between the two countries, when B is the base country, is the ratio 45 to 3 or 15 rupees to the dollar. In other words, for every dollar spent on oranges of the specified quality in country B, 15 rupees would have to be spent in country A to obtain the same quantity and quality of oranges.
PPPs are calculated for individual products, for basic headings, and for each of the various levels of aggregation up to and including GDP. The calculation is made in three stages: first at the product level, where price relatives are calculated for individual products; second at the basic heading level, where the price relatives calculated for the individual products in the basic heading are averaged to obtain unweighted PPPs for the basic heading; and third at the aggregation levels, where the PPPs for the basic headings covered by the aggregation level are weighted and averaged to obtain weighted PPPs for the aggregation level. The weights used to aggregate the PPPs in the third stage are the expenditures on the basic headings.
PPPs are still price relatives when they refer to a basic heading, an aggregation level or to GDP. It is just that in moving up the levels of aggregation the price relatives refer to increasingly complex assortments of goods and services. Thus, if the PPP for GDP between country A and country B is 10 rupees to the dollar, it means that for every dollar spent on GDP in country B, 10 rupees would have to be spent in country A to purchase the same volume of goods and services. This does not mean that the baskets of goods and services will be identical in both countries. The composition will vary between countries reflecting their economic, social, and cultural differences although both baskets will, in principle, provide equivalent satisfaction or utility.