17: limitations of GDP

Real GDP per capita 

• To compare changes in standard of living (either intertemporally or internationally) the growth rate of real GDP per person is called read GDP per capita

• Real GDP per person = real GDP/ population 

• If the real GDP per person is increasing, it is very often associated with economic growth 

International comparisons of SOL (standard of living) 

• Market exchange rate comparison 

  • Real GDP of one country needs to be converted into the same currency 

• Purchasing power parity comparisons 

  • The same prices should be used to value the goods and services in the countries being compared 

Limitations of GDP 

1. GDP doesn’t include ‘non-market’ activity 

   1. Domestic activity 

   2. GDP does not include charitable or voluntary work 

   3. These activities are not counted in GDP as they are not traded 

   4. Understate SOL 

2. GDP does not include buying and selling of second-hand goods.

   1. Argued that this is a transfer of ownership 

   2. It does not lead to any current production 

      1. Benefit both buyers and sellers 

      2. Benefit to buyers- the buyers get to buy and use the goods, they may not have been able to afford otherwise 

      3. Benefit to sellers- sellers pocket the extra cash, which can be used to buy other goods and services 

   3. Understate SOL

3. GDP does not include transactions taking place in the underground economy 

   1. Underground economy- aka ‘cash economy’ is an economy that is purposely hidden from the view of the government to avoid taxes and regulations or because the goods are illegal.

   2. Understate SOL 

4. GDP does not include the transaction taking place in the stock exchange 

   1. Argued that it is only a transfer of ownership and do not lead to any current production 

   2. Understate SOL, of people making profits by participating in the stock market transactions 

   3. Overstate SOL, of people making losses by participating in stock market transactions 

5. There is no correlation between GDP and leisure 

   1. Voluntary increase in leisure - understate 

   2. Voluntary decrease in leisure - overstate 

   3. In voluntary increase leisure - overstate 

6. There is no correlation between GDP and the crime rate 

   1. Crime rate decrease - understate 

   2. Crime rate increase - overstate

7. GDP does not reflect social ills/ social cost of production like pollution, environmental degradation. 

   1. Overstate SOL 

8. GDP values all goods equally 

   1. Understate SOL - in producing more merit goods 

   2. Overstate SOL - in producing demerit goods 

9. GDP does not consider the inequalities in the distribution of income and output between individuals 

   1. Rich people- understate SOL 

   2. Poor people- overstated SOL 

10. GDP is not a good measure of health, welfare and wellbeing 

    1. Negative influences are not considered - overstate SOL 

11. GDP does not consider changes in product quality 

    1. Improvements in product quality - understate SOL 

    2. Deterioration in the quality - overstate SOL 

12. GDP does not consider “quality of life issue” 

    1. Overstate SOL

Alternative standard of living 

• Green GDP

  • Green GDP=GDP- estimated cost of greenhouse gas emissions and pollution 

• Happy planet index (HPI)

  • GDP- estimated cost of depleting non-renewable resources  

• Human development index (HDI) 

  • HDI is a summary composite index that measures a country’s average achievements by including both economic and social indicators to measure a country’s achievements 

  • 

• Genuine progress indicator (GPI)

  • Take fuller account of the well-being of a nation, only a part of which pertains to the health of the nation’s economy, by incorporating environmental and social factors 

  • It considers: 

    • Value of household production and voluntary work done by people 

    • Cost of environmental damage 

    • Depletion of non-renewable energy resources 

    • Inequality in distribution of income 

    • Cost reduced leisure time 

    • Cost of crime 

Practice exam question

4 marks 

Discuss two limitations of using GDP as a measure of people’s living standards and propose  two alternative measures that could provide a more comprehensive understanding of a nation’s well-being. 

Define GDP 

• They use real GDP per person  or GDP per capita to measure the people's standard of living. The higher the number the better the living standard. It shows that the people in the economy are spending/ earning how much per person. 

Discuss the two limitations 

• Does not include buying or selling of second hand goods 

  • They argue that it is merely a transfer of ownership and that it does not produce anything new and therefore should not be considered in GDP. 

  • Therefore they understate the standard of living. 

• Does not include transactions taking place in the stock market 

  • They also consider this a transfer of ownership and do not have any current production involved. 

  • People who invest and gain a profit in return have an understated standard of living 

  • People who invest and acquire a loss in return have an overstated standard of living. 

Give two alternative measures 

• HDI 

  • HDI or human development index is a summary composite index that measures a country’s average achievements. This method considers 3 main factors, which include 2 social factors (life expectancy and education) as well as one economic factor (GNI or gross national income). 

  • The value of HDI ranges from 0 to 1, 0 being not developed and 1 being developed. 

• GPI

  • GPI or genuine progress indicators take fuller account of the well-being of a nation, only a part of which pertains to the health of the nation’s economy, by incorporating environmental and social factors. It considers cost of crime, inequality in income distribution and more factors that real GDP per capita is not able to include.