SOL GA1-- circular flow of income

purchasing power parity definition (ppp)

• the amount of a country’s currency that is needed to buy the same quantity of local goods and services that can be bought with USD1 in the states (base price normally : USD1)

• accounts for different price levels and different purchasing power across countries

PPP exchange rate (real)

an exchange rate between currencies that make their buying power equal to the buying power of US1 and therefore equal to each other (reflects purchasing power)

SOL defintion

refers to the level of well being of an individual or a household within the country (includes both material and non material aspects of life

material SOL

quantity of goods and services available to an individual in a particular year , measured by real GDP per capita

eg. income , goods and services people can consume

non material SOL

quality of life

eg. personal safety, cleaner water , happiness/stress level

why national income statistics (GDP and GNI) is not the “true” value of output

• do not include underground markets (illegal businesses)

• do not account for value of negative externalities (cost imposed on third party)

• do not include non marketed output (eg , housewife)

• do not take into account quality improvements in goods and services

underground economy / unrecorded economy definition

refers to the sector of the economy where activities are hidden from the governments . Goods are traded, income is generated but these transactions go unrecorded , hence such economic activities are undeclared

• eg: illegal activities / concealed legal activities (undeclared transactions)

Limitations of using NIS to measure true value of output , under ground economy

• For example, in India , where roughly 14% of its population are illegal street vendors. the amount of goods and services they sell are not registered and captured by the government . Thus, not counted in the country’s GDP .Hence , underestimating the true value of output

non marketed output definition

• activities that take place without an exchange of money (normally underestimated)

• GDP can only measure and record output produced and sold in markets , does not record non marketed output

• EG : housewife

Limitations of using NIS to measure true value of output , Non marketed output

• Non marketed output : GDP only measures total output of goods and services produced by economy. But housewife produce service : take care of children , clean up . But not paid and transacted , this service not captured. Underestimate true value of output (services not bought or sold in the market)

if quality of products ___how does this affect GDP

• quality does not affect GDP only quantity

• if quality improve , but same output produced , no change in GDP

• if quality worsen, same output produced, no change in GDP but living standards may worsen

GDP does not consider external costs and depletion of natural resources

• do not consider resource depletion + value of negative externalities , both of which reduce society well being

• for example , more pollution generated from factories working to increase output hence real GDP increases , but harmful gases produce affect third party (SOL drop)

Limitation of using NIS to compare SOL over time

• real GDP per capita does not reflect income distribution 

• May underestimate SOL due to unrecorded activity like underground activity / non marketed output (goods and services produced but not captured)

• May not fully capture non-material SOL, non material SOL is so broad so must measure quality of life by looking at other aspects (quality of healthcare/leisure activity )

limitation of using real GDP per capita to calculate material SOL over time , explanation (underscored activity)

• May underestimate SOL due to unrecorded activity like underground activity / non marketed output (goods and services produced but not captured)

Real GDP per capita may underestimate the SOL if there are more activities in the underground economy/unrecorded. This includes legal goods and services that are not officially recorded like unregistered businesses as well as illegal activities like drug trafficking. 

• For example, in India , where roughly 14% of its population are illegal street vendors. The profits they earn from selling goods and services by the streets is not reported to the government and not included in real GDP per capita but they still have the ability to consume more goods and services

As a result, the official GDP per capita may underestimate the improvement of the material SOL

(for non material SOL can say that : tax not collected by government , government have lesser to spend on public investment [like more infrastructure : hospitals/schools, ] lesser access to education/healthcare , non material SOL fall)

limitation of using real GDP per capita to calculate material SOL over time , explanation (income distribution)

• Real GDP per capita does not reflect income distribution 

Real GDP per capita does not reflect income distribution because it only shows the average income per person and does not indicate how income is evenly distributed among the population. Although real GDP per capita rises over time , if income inequality is significant,income gains mainly go to the rich minority. 

• For example in South Korea , real GDP per capita increased slightly from about $32,400 in 2022 to about $33,100 in 2023, showing economic growth. However, income is unevenly distributed, with the top 10% receiving around 46% of total income, meaning a significant portion of GDP goes to a wealthy minority rather than the average citizen. Hence, the majority of the population does not experience an increase in income as income gains mainly go to the rich minority. Thus, there is little to no improvement in material SOL.(OVER TIME)

Thus,when comparing over time, real GDP per capita may overstate improvements in SOL if rising income is unevenly distributed.

(for non material can say lesser income=lesser access to healthcare /education /safe housing)

limitation of using real GDP per capita to calculate material SOL over time , explanation (may not fully consider non material SOL)

• May not fully capture non-material SOL, non material SOL is so broad so must measure quality of life by looking at other aspects (quality of healthcare/leisure activity ) 

Real GDP per capita may not fully capture non-material aspects of SOL like leisure time

• For example, in South Korea, the average working hours in 2023 was about 1,874 hours per year. This is significantly higher than listed by the OECD (organisation for economic co-operation and development) average of 1,719 hours. Such long hours can lead to an increase in goods and services produced leading to more sales and increasing real GDP. Assuming that population remains unchanged, real gdp per capita will increase. However, longer working hours means workers have lesser leisure time to spend with their friends and family, decreasing the quality of non material SOL

Hence, although real GDP per capita has increased, the non material SOL is overstated.

over time definition

looking at same country over a time period

across space

different countries , uses real gdp per capita adjusted to PPP

Limitations of using NIS to compare across space

1. difference in income distribution

2. difference in size of hidden economy

3. GDP makes no distinction about the composition of output

Limitations of using NIS to compare across space , difference in income

• Overstating the difference , difference much smaller than what you think due to difference in the distribution of income 

Two countries may have similar real GDP per capita (adjusted to PPP) , but very different income distributions. A country with greater income inequality will have lower material SOL for the average citizen while the rich minority get to experience a higher material SOL. 

• For example , South Africa’s real GDP per capita is about US$13,000 while Indonesia’s real GDP per capita is about US$11,900. At first glance, this suggests that South Africa has a higher material SOL. However, South Africa has very high income inequality. Hence, income gains mainly go to the rich minority. In contrast,  Indonesia has a more equal income distribution , resulting in more households to be able to consumer more goods and services , improving their material SOL.

Thus, GDP per capita overestimates the SOL in the more unequal country

• If talking about non material SOL , can say that income inequality leads to unequal healthcare opportunities , reducing the life expectancy in the country. 

Limitations of using NIS to compare across space , hidden economy

• Undertestimates countries output because a large part of production of agricultural sector is not traded → diff in size of hidden economy 

Real GDP per capita may underestimate the material SOL in countries with a larger hidden economy as economic activities are not captured under the official national income statistics. 

• For example, India and the USA. India’s real GDP per capita is about US$2,600 while the USA is about US$80k. Based solely on these figures it appears that the material SOL in the USA is higher than India. However, India’s hidden economy is estimated to be about 40-50% of its official GDP while USA’s hidden economy takes up 5-10% of GDP. Many people in india earn income through informal jobs like street vendors who take up 14% of indias population.But this income is not reported in India's real GDP per capita, underestimating people’s actual income to consumer goods and services . thus , underestimating the material SOL 

Limitations of using NIS to compare across space (composition of output )

• GDP makes no distinction about the composition of output → eg, govt spend on military goods , total GDP increases BUT sol (material) does not get affected

Real GDP per capita measures the total value of goods and services produced but does not distinguish between the different types of output. However, not all output contributes equally to improvements in the non material SOL.

• For example , Qatar vs Germany. Qatars real GDP per capita is about 80kUS and Germany's is about 52kUS. Solely on the figures itself, it seems like qatar has a higher non material SOL. However, real GDP per capita does not show the type of goods and services produced that may affect non material SOL. for example , in Qatar , due to oil production it has emitted alot of greenhouse gases to residents living near the area. Due to this air pollution , residents living near these industrial sites may fall ill, deteriorating their healthcare which is a non material SOL. 

Hence,  overestimating the non material SOL in Qatar