The ICP calculates PPPs from the expenditure side of the national accounts. This requires countries to provide a set of national annual purchasers’ prices and a detailed breakdown of final expenditures on GDP. The prices should refer to a selection of products chosen from a common basket of precisely-defined goods and services. The expenditures should be broken down into basic headings according to a common classification. Both prices and expenditures should refer to the year of the comparison and both should cover the whole range of final goods and services included in GDP. In addition, the prices should be consistent with the prices underlying the expenditure values and the products priced should be comparable across countries.
The basis of a comparison is the identity: expenditure = price x volume. Volumes are obtained by dividing expenditures by prices. If the volumes are to be estimated correctly, the prices provided should be those used to derive the expenditures. Deflating with prices that are not consistent with the expenditures will result in volumes being underestimated if prices are too high and overestimated if prices are too low.
The final expenditures on GDP that countries report for the comparison year are in principle estimated using national annual purchasers’ prices of actual market transactions. Consistency requires that countries provide prices that are national – that is prices that have been collected and averaged over the whole country and take account of regional price variations - and annual - that is prices that have been collected and averaged over the whole year and take account of seasonal price variation and general inflation. These national annual prices have to be purchasers’ prices – that is the prices paid by final purchasers and which include supplier’s retail and wholesale margins, transport and insurance charges, and non-deductible tax on products. The purchasers’ prices have to be market or transaction prices as well – that is the actual prices agreed by buyers and sellers and inclusive of all discounts, surcharges, rebates and, in the case of certain services, invoiced service charges and voluntary gratuities.
Pricing comparable products ensures that the differences in prices between countries for a product reflect actual price differences and are not influenced by differences in quality. If products are not comparable, the price differences between countries will only be apparent as they will reflect both price differences and quality differences. As a result, price levels will either be too high or too low with the corresponding underestimation or overestimation of volume levels.
Products are said to be comparable if they have identical or equivalent physical and economic characteristics. In other words, their technical parameters and price determining properties are either the same or similar. In this context, equivalence or similarity between products is defined as meeting the same needs with equal efficiency so that purchasers are indifferent between them and are not prepared to pay more for one than for the other. Comparability is obtained in ICP comparisons by countries pricing product specifications that fully define the products to be priced in terms of the principal characteristics that influence their market or transaction price. The characteristics specified cover both the product itself as well as the transaction.
Finally, for completeness, it should be mentioned that besides the price and expenditure data, countries have also to provide annual average exchange rates and the mid-year population for the comparison year.