Lesson summary: The limitations of GDP
|quality of life||(sometimes called “well-being”) the standard of health, happiness, security, and material comfort of an individual, a group of people, or a nation|
|non-market transactions||economic activity that takes place in the informal sector (from babysitting, to lawn mowing, to illegal drug sales), sometimes called the gray market or the black market economy; non-market transactions are not recorded, taxed, or officially monitored by the government. Because of this, the output and income generated is not included in the calculation of a nation’s GDP.|
|income inequality||when a disproportionate share of a nation’s income is earned by a small minority of households; for example, when the top of households earn of the total income in a country, there is a high degree of income inequality; GDP does not account for income distribution in any way.|
|sustainability||the ability of a system to endure indefinitely into the future; an increase in GDP will only be sustainable as long as it does not deplete natural resources too rapidly nor exploit the environment in a way that diminishes the quality of life of the nation’s households over time.|
|economic bads||any outcome from economic activity that creates negative value for society, such as air pollution from cars that harms human health and the environment; unsustainable economic growth may diminish the quality of life of a nation’s people.|
|real GDP per capita||the real gross domestic product of a nation, divided by the nation’s population; this measure is an indication of the average income of a nation’s people|
|depreciation of capital||the decrease in the value of a nation’s capital stock over time; GDP accounts for investment in new capital but does not subtract the lost value of depreciated capital. Because of this, GDP may overstate the amount of economic activity in nations with rapidly depreciating capital stocks.|
|Human Development Index (HDI)||a composite measure of nation’s social and economic development developed by the United Nations that includes measures of health, wealth, and education|
|Genuine Progress Indicator (GPI)||a measure of a nation’s quality of life that includes the income and output measured by gross domestic product. This measure subtracts out the costs of negative effects related to economic growth such as crime, environmental degradation, resource depletion, and the costs of climate change. GPI nets the positives and negatives of economic activity to provide a more accurate measure of a nation’s quality of life than GDP alone.|
|Happy Planet Index (HPI)||a measure of a nation’s quality of life that includes survey results on happiness, life expectancy at birth, the degree of inequality across society, and the ecological footprint|
The limitations of GDP
- The exclusion of non-market transactions
- The failure to account for or represent the degree of income inequality in society
- The failure to indicate whether the nation’s rate of growth is sustainable or not
- The failure to account for the costs imposed on human health and the environment of negative externalities arising from the production or consumption of the nation’s output
- Treating the replacement of depreciated capital the same as the creation of new capital
- The Human Development Index (HDI)
- The Genuine Progress Indicator (GPI)
- The Happy Planet Index (HPI)
- Some people mistakenly think a higher income (and larger GDP) is correlated with a higher quality of life and more happiness, but only up to a certain income level. Some studies have actually found that beyond a certain income level, additional increases in income are no longer correlated with higher quality of life. Instead, other, non-income factors (such as the equity of income distribution and access to education and health-care) are more closely correlated with a happier, healthier society.
- Some of the poorest countries in the world may actually appear poorer than they really are if we only consider their official GDP figures. If a large percentage of the workforce is employed in the informal sector, then their incomes will not be reflected in the nation’s GDP. As a result, the nation’s GDP will appear smaller than it would be if all economic activity were included.
- Do higher incomes and more output always equal a higher quality of life for the people experiencing such growth? Explain.
- Under what circumstances would an increase in a nation's average income not lead to an increase in the income of the typical, median household?
- Choose an alternative measure of well-being and describe what it includes.