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How well GDP measures the well-being of society
Does GDP capture everything we care about in an economy?
Key points
- GDP is an indicator of a society’s standard of living, but it is only a rough indicator because it does not directly account for leisure, environmental quality, levels of health and education, activities conducted outside the market, changes in inequality of income, increases in variety, increases in technology, or the—positive or negative—value that society may place on certain types of output.
- The standard of living is all elements that affect people’s happiness, whether these elements are bought and sold in the market or not.
Introduction
You might have heard the term standard of living before—it means all of the elements that contribute to a person's happiness.
Standard of living is a broad term that encompasses many factors—including some that are not bought and sold in the market and some that are. The level of GDP per capita, for instance, captures some of what we mean by the term standard of living, as illustrated by the fact that most of the migration in the world involves people who are moving from countries with relatively low GDP per capita to countries with relatively high GDP per capita.
To understand the limitations of using GDP to measure the standard of living, it is useful to spell out some things that GDP does not cover that are relevant to standard of living.
Limitations of GDP as a measure of standard of living
Because many factors that contribute to people's happiness are not bought and sold, GDP is a limited tool for measuring standard of living. To understand it's limitations better, let's take a look at several factors that are not accounted for in GDP.
GDP does not account for leisure time. The US GDP per capita is larger than the GDP per capita of Germany, but does this prove that the standard of living in the United States is higher? Not necessarily since it is also true that the average US worker works several hundred hours more per year more than the average German worker. The calculation of GDP does not take German workers extra weeks of vacation into account.
GDP includes what is spent on environmental protection, healthcare, and education, but it does not include actual levels of environmental cleanliness, health, and learning. GDP includes the cost of buying pollution-control equipment, but it does not address whether the air and water are actually cleaner or dirtier. GDP includes spending on medical care, but it does not address whether life expectancy or infant mortality have risen or fallen. Similarly, GDP counts spending on education, but it does not address directly how much of the population can read, write, or do basic mathematics.
GDP includes production that is exchanged in the market, but it does not cover production that is not exchanged in the market. For example, hiring someone to mow your lawn or clean your house is part of GDP, but doing these tasks yourself is not part of GDP.
GDP has nothing to say about the level of inequality in society. GDP per capita is only an average. When GDP per capita rises by 5%, it could mean that GDP for everyone in the society has risen by 5% or that the GDP of some groups has risen by more while the GDP of others has risen by less—or even declined.
GDP also has nothing in particular to say about the amount of variety available. If a family buys 100 loaves of bread in a year, GDP does not care whether they are all white bread or whether the family can choose from wheat, rye, pumpernickel, and many others—GDP just looks at whether the total amount spent on bread is the same.
Likewise, GDP has nothing much to say about which technology and products are available. The standard of living in, for example, 1950 or 1900 was not affected only by how much money people had—it was also affected by what they could buy. No matter how much money you had in 1950, you could not buy an iPhone or a personal computer.
In certain cases, it is not clear that a rise in GDP is even a good thing. If a city is wrecked by a hurricane and then experiences a surge of rebuilding construction activity, it would be peculiar to claim that the hurricane was therefore economically beneficial. If people are led by a rising fear of crime to pay for installation of bars and burglar alarms on all their windows, it is hard to believe that this increase in GDP has made them better off. In that same vein, some people would argue that sales of certain goods, like pornography or extremely violent movies, do not represent a gain to society’s standard of living.
Does a rise in GDP overstate or understate the rise in the standard of living?
The fact that GDP per capita does not fully capture the broader idea of standard of living has led to a concern that the increases in GDP over time are illusory. It is theoretically possible that while GDP is rising, the standard of living could be falling if human health, environmental cleanliness, and other factors that are not included in GDP are worsening. Fortunately, this fear appears to be overstated.
In some ways, the rise in GDP actually understates the actual rise in the standard of living. For example, the typical workweek for a US worker has fallen over the last century from about 60 hours per week to less than 40 hours per week. Life expectancy and health have risen dramatically, and so has the average level of education.
Since 1970, the air and water in the United States have generally been getting cleaner. New technologies have been developed for entertainment, travel, information, and health. A much wider variety of basic products like food and clothing is available today than several decades ago. GDP does not capture leisure, health, a cleaner environment, the possibilities created by new technology, or an increase in variety.
On the other side, rates of crime, levels of traffic congestion, and inequality of incomes are higher in the United States now than they were in the 1960s. Moreover, a substantial number of services that used to be provided, primarily by women, in the nonmarket economy are now part of the market economy that is counted by GDP. By ignoring these factors, GDP would tend to overstate the true rise in the standard of living.
GDP is rough, but useful
A high level of GDP should not be the only goal of macroeconomic policy—or broader government policy. But, even though GDP does not measure the broader standard of living with any precision, it does measure production well, and it does indicate when a country is materially better or worse off in terms of jobs and incomes. In most countries, a significantly higher GDP per capita occurs hand in hand with other improvements in everyday life along many dimensions, like education, health, and environmental protection.
No single number can capture all the elements of a concept as broad as standard of living. Nonetheless, GDP per capita is a reasonable, rough-and-ready measure of the standard of living.
Summary
- GDP is an indicator of a society’s standard of living, but it is only a rough indicator because it does not directly account for leisure, environmental quality, levels of health and education, activities conducted outside the market, changes in inequality of income, increases in variety, increases in technology, or the—positive or negative—value that society may place on certain types of output.
- The standard of living is all elements that affect people’s happiness, whether these elements are bought and sold in the market or not.
Self-check question
Explain briefly whether each of the following would cause GDP to overstate or understate the degree of change in the broad standard of living.
- The environment becomes dirtier.
- The crime rate declines.
- A greater variety of goods become available to consumer.s
- Infant mortality declines.
Review question
List some of the reasons why GDP should not be considered an effective measure of the standard of living in a country.
Critical thinking questions
How might a “green” GDP be measured?
Want to join the conversation?
Can some please help with the final question:"List some of the reasons why GDP should not be considered an effective measure of the standard of living in a country."(11 votes)- If you build a coal fired electricity generation plant, which allows more efficient production of manufactured goods, you may actually reduce the standard of living by a) reducing the number of manufacturing jobs and b) worsening air quality downwind of the new generating plant. There are many types of events (earthquakes, hurricanes) which cause an increase in GDP by forcing individuals, corporations and governments to increase expenditures to replace damaged and destroyed infrastructure, just to recover the lost standard of living.(3 votes)
Is the Human Development Index (HDI) a better measurement of standard of living than GDP?(19 votes)- i guess so because it accounts for a person's health and income- which go into the "production" of a product which is then exchanged in a market. Even though it's more concerned with the measurement of the development of a nation, i'm assuming that in terms of someone's standard of living, HDI checks off those boxes.
http://hdr.undp.org/en/content/human-development-index-hdi(6 votes)
umm hi khan this is seddie here SO is stocks part of dis(0 votes)
No , stock is not part of GDP because it does not include any new product.(26 votes)
- Critical thinking questions
How might a “green” GDP be measured? If BY "Green" you mean: cleaner way to produce power (or energy) then this would be a direct factor calculated in GDP, it effects businesses as an expense & energy is an industry within the US.(8 votes)
I think it means "only green GDP" as in GDP produced by "green ways". For that we would need a definition, such as: only renewable resources. Then we would measure how much GDP is produced with renewable resources as primary goods.(6 votes)
what is the formula of GDP(1 vote)
gdp=c+i+g+(x-im) c= consumer spending, i= investment spending, g= government spending, x= exports, im= imports(11 votes)
If I was to make my own index to measure human-wellbeing, which measures should I include and why would it be better than GDP and even HDI(2 votes)
Like any other measure, it depends on what you believe is an aspect of that thing. So, if you are trying to come up with a measure of wellbeing that is an improvement over real GDP per capita or HDI, what are some things that you think make life better that aren't included in real GDP?
To get some ideas, it might be a good idea to read this article which has some other measures of wellbeing to get some ideas: https://www.khanacademy.org/economics-finance-domain/ap-macroeconomics/economic-iondicators-and-the-business-cycle/modal/a/lesson-summary-the-limitations-of-gdp(4 votes)
- Are there countries where the GDP widely misrepresents the standard of living or is this all in theory? To clarify, are there countries that have a low standard of living but a high GDP, or do all countries correlate with their GDP and the limitations are just theoretical?(2 votes)
- It really depends on what you mean by "standard of living". A commonly used measure of standard of living is the human development index (HDI). A good example of a mismatch between HDI and GDP is Equatorial Guinea. It has a real GDP per capita slightly higher than Croatia. But, Equatorial Guinea's HDI is 0.59 while Croatia's is 0.82 (a higher HDI is better, and 1 is the highest HDI possible).(3 votes)
- If consumers and sellers are in the same country, the net wealth accumulation of that country would be zero, right? How would economy of that country increase or decrease?
Does this question make any sense?(3 votes) 
In the Critical thinking questions section, what does he mean by ' How might a "green" GDP be measured?'(1 vote)- I would assume it means, "How might an economy that prioritizes goods and services believed to have less negative environmental impact be measured?" Most often when people would think of an economy that is more "green", they would generally mean that the energy sector is using renewable energy such as wind and solar, which doesn't lead to as much air and water pollution. However, it is usually obtained at a greater cost. So a country with a more "green" economy may see a rise in GDP because of the greater cost of generating energy, and may have a corresponding rise in standard of living because of reduced pollution.(3 votes)
- My take-away for this is that things we labor for ourselves is not measurable domestically. It seems that this unmeasured labor power we do for ourselves and not someone else could have a huge impact on the economy. Self-education for instance (what we are doing now) will in the long term likely improve the standard of living and GDP in the future. The more people can do the more labor power they produce.
The more people depend on others to provide for them, the less labor power will be produced, as it is taking two to provide for one. (As we already do for children, having to labor for them and ourselves both, two to support one.) The police labor to defend others, so a larger labor force is used for fewer results. As opposed to a population that can defend itself and requires minimal police, then it would have a greater labor force and production.
I don't think we have the right tools to really grasp how this relates to standard of living or happiness.(2 votes)
