Tuesday, July 8, 2008

How Good Is GDP To Measure Standard of Living? (Unit 3)

GDP is basically used to measure the economic well being of population in a country through the concept of standard of living. From GDP, economists derive real GDP per person (per capita).

The nominal GDP (GDP at current prices) figure must be adjusted to net off the effect of inflation rate which artificially push up the value of GDP. Hence economists arrive at real GDP

Per capita means real GDP divided by total number of population

Limitations of GDP when measuring standards of living:

1. Fails to take into account income disparity. There are 2 ways to look at this. First, some countries although having extremely high GDP but this doesn’t mean each individual in that country is rich. It could be those few very rich individuals that inflate this figure. Second, among states or region. GDP of China ranks second in the world, but the income gap between the northern China & southern China is widening

2. GDP figures ignore the impact of negative externalities which may reduce standard of living. Sometimes high GDP figures are achieved at the expense of environmental degradation e.g. more pollution & congestion. As such, our standard of living may not be that high as being anticipated

3. Ignores the factor of leisure time which also contributes to higher standard of living. Sometimes high GDP figures are achieved by sacrificing our leisure time. There is no point we achieved high GDP or high income but at the end of day, having no time for ourselves. British workers have the longest working hour in Europe, so even if GDP in UK is higher compared to the rest of Europe, can we conclude an average Britons are better off?

4. Doesn’t take into account black economy (some does e.g. Nigeria, Columbia, Thailand). Illegal activities which are not openly traded such as piracy, prostitution, weaponry, illegal drugs & smuggling will not be taken into account. If all this were to be considered, GDP figures in many countries could be much higher than reported. E.g. Thailand & Nigeria have the world’s largest black economies, both accounting for more than 70% of their GDP. If they were to take it out, then their GDP figures will be very low

5. Doesn’t take into account non-monetary activities. Goods that are not traded in the market e.g. production for self consumption, voluntary work & DIY work will not be counted in GDP. If we were to do so, just like in (4), the value of GDP could be much higher

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