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Limitations of GDP

GDP is the most commonly used measure of output, but it leaves some things out. Learn about the limitations of GDP in this video.

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  • duskpin tree style avatar for user Jimmy Kim
    Purchasing power parity measures what, exactly? To be clear, how is it different from nominal GDP?
    (4 votes)
    Default Khan Academy avatar avatar for user
    • primosaur ultimate style avatar for user Vulcan Hephaestus
      Purchasing power parity (PPP) is an economic theory that compares different countries' currencies through a "basket of goods" approach. According to this concept, two currencies are in equilibrium or at par when a basket of goods (taking into account the exchange rate) is priced the same in both countries.
      PPP takes into account cost of living, inflation rates, etc., to accurately describe GDP per capita.
      Country X has a GDP per capita of $200,000.
      Country Y has a GDP per capita of $100,000.
      On the rankings, Country X will be higher than Country Y, right? But if you take into account the fact that Country X has a high cost of living and a high inflation rate, while Country Y has a low cost of living and a low inflation rate, it seems that Country Y should be higher on the rankings relative to Country X.
      This is what PPP does. Under PPP rankings, Country Y will be higher than Country X.
      Purchasing power parity is calculated by S=P1/P2,
      where S is the exchange rate,
      where P1 is the cost of good X in currency 1
      where P2 is the cost of good X in currency 2.
      As for how nominal GDP and PPP are different:
      Nominal GDP is calculated by GDP = Consumer Spending + Investment by industry + Excess of exports over imports + Government Spending
      Real GDP adjusts the nominal GDP for inflation, using a selected 'base year'.
      Purchasing Power Parity adjusts the nominal GDP for inflation and cost of living by comparing two countries' currencies.
      Hope that helps!
      (14 votes)
  • blobby green style avatar for user shantanu.khandkar
    At , if I were to pay the babysitter in cash and the transaction is not registered with the IRS, wouldn't that still count as a household expense and add to the total consumption and therefore add to the GDP? It wouldn't be under the particular heading of payments to babysitter perhaps, but it would still affect my bottom line.
    (2 votes)
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  • blobby green style avatar for user lj04159
    What would happen without GDP?
    (2 votes)
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    • aqualine ultimate style avatar for user Woah
      Demand would outstrip supply of food, gas, and other necessities. If the collapse affected local governments and utilities, then water and electricity might no longer be available. A U.S. economic collapse would create global panic.
      (3 votes)
  • duskpin ultimate style avatar for user jeanethe rodriguez
    this question: How does per capita GDP in the following countries "stack up" against America's (in percentage terms)?
    Instructions: Enter your responses as a percentage rounded to one decimal place.

    us: 55,980
    canada: 47,540
    china: 7,930
    cuba: 6,000



    Do I have to divide the U.S and Canada and multiply by 1% to find the percentage for Canada?
    (1 vote)
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  • blobby green style avatar for user Henry Silverberg
    What are the drawbacks and limitations associated with using GDP as a measure of economic output?
    (1 vote)
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  • blobby green style avatar for user Ruobing Zhang
    Hi I want to tell you that Macau is not a country!It's a part of China. Please correct it.Thanks.
    (0 votes)
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Video transcript

- [Instructor] In other videos we have already talked about the idea of GDP in some depth. Gross domestic product, a measure of the aggregate goods and services produced in a country in a year. But what we're going to discuss in this video is how good a measure GDP is and in particular some of the things that GDP does not measure. So in general what's the motivation for wanting to know the aggregate goods and services produced by a country? Well you could view it as a sign of economic activity, so it's economic, economic activity. You could view it as the size or influence of an economy. Size/influence of economy. And then if you take GDP and you divide by the number of people in a country, you get things like GDP per capita. GDP per capita, what you could view really as GDP per head. And this you could view as well that's an indicator of well-being, with the idea that well if there's just more goods and services produced per person, that maybe people in that country are going to be better off. But as we already touched on, what is it not measuring? Well one thing that GDP does not measure is non-marketed goods. What do I mean by non-marketed goods? So let's say that I have to go to the airport, so this is the airport here, my best drawing. That's a terminal, there's a plane. That's the point of this isn't to draw an airport, but you get the idea, that's an airport. And I need to go from my house to the airport. If I call up a taxi or an Uber or Lyft or something like that and I take it to the airport, so they drive me to that airport, that fare that they charge me, that will be included in GDP. On the other hand if I were to get my wife to drive me to the airport, all of a sudden that would not be counted in GDP, even though the exact same service has been performed. Someone took me in their car from my house to the airport. And that's because my wife or your roommate or your best friend giving you a ride is a non-marketed service. They're not trying to sell that service. They're just doing that to you as a favor. But it was a service provided to you, but it would not be captured in GDP. One that is often talked about is child care. If, that's my best drawing of a child really fast, if you hire a babysitter or if you hire a nanny to take care of your child, that should be included in GDP. Although if you yourself take care of your child, that will not be included in GDP because once again, you taking care of your child would be a non-marketed service. Now the other thing that GDP does not include are illegal activity or you could even say under the table activity, some of which is not illegal. For example if someone were to pay their babysitter, and if it doesn't get registered in taxes someplace, well even that will not be reflected in the GDP number. It's not an illegal activity, but it should've officially been registered with the IRS and then it would've been counted as GDP, but in this case, it wouldn't have. And also of course you have black markets, illegal activity that for sure would not be included in GDP. If someone were to illegally sell you fireworks, let's say they're banned in your state, and of course they're not gonna report it to the government. Well of course that good and/or service is not going to be reflected in GDP. But you might say okay that's all right, you're gonna miss some things, but directionally if GDP is growing, especially if GDP per capita is growing, surely that is a good thing. And in general you're probably right. It probably is a good thing, but there's also things that GDP is not capturing. It is not capturing even if you were able to measure non-marketed goods and services or under the table or illegal activity, it doesn't capture things like let's say pollution. You could have a country whose GDP is growing very very fast, but in the process, the country gets very very polluted. Maybe that makes the quality of life go down in certain areas. Health is another issue. In general countries with a high GDP per capita usually do have good health care, mainly because they have more resources for health care. But you wanna look at that. How is the health trending in a country? And then you could even think about stuff like stress or a feeling of community or support. These are all things that would affect any human being's well-being, but they are not of course captured in GDP. Now to appreciate the different ways of ranking countries in an attempt to get at well-being, you could first of all look at GDP rankings. So here are rankings by the World Bank for 2016. You can see the United States is on top with 18.6 almost trillion dollars of GDP as measured by the World Bank, and you see the ranking. Now if you wanted to go by per capita, because you say hey this doesn't tell you how many people are there. What matters is how much productivity divided by the number of people if you really wanna measure per person well-being. Well then you might look at something like this, GDP per capita. And notice here, the United States is still quite high, but it's nowhere near as high as Luxembourg. The reason why Luxembourg didn't show up on the other list is it is a very very small country. It's population is very small compared to the United States. Same thing for Switzerland or for Macau. Now another thing to appreciate is, this GDP per capita just takes the nominal GDP and divides it by the number of people there are in a country. But it does not measure or indicate things like wealth inequality. It's not that every person in Luxembourg gets exactly $103,000 worth of goods and services. Depending on the country, there might be more of a middle class or less of a middle class. There might be more wealth inequality or less wealth inequality, and once again that is not captured by GDP. Also even the GDP per capita doesn't really tell you how much you can buy with that per capita GDP. And so that's why people look at things like purchasing power parity. This is a sense of per capita GDP, but adjusted for how much you could buy with those resources that are measured in U.S. dollars. So now all of a sudden, Qatar at the top. Qatar was pretty high, but I guess you can buy more and get more goods and services with that nominal GDP per capita as measured in U.S. dollars in Qatar than you could say in the United States. So I will leave you there. There's no such thing as an absolutely perfect measure of economic activity, much less well-being, but GDP is the best measure that we have, although I encourage you to think of others. For example, the UN has tried to measure happiness. They have this ranking of happiness. They have an annual World Happiness Report. And I'm not gonna go into all of the details, but beyond GDP, it also considers things like health or other measures of well-being. And as you can see, the countries at the top here tend to have fairly high GDPs, but this ranking is not the same as the ranking that we saw on the GDP per capita with the purchase power parity. And so these are all very interesting things to think about.