9/19/11

Problems with GDP as a measurement of well-being and alternatives to GDP, part 2



Why GDP isn’t a good measure for the well-being of a nation.   
While aggregate GDP isn’t a good measure because more populated  countries generally have a higher GDP, per capita GDP (total GDP divided by population) is also not a good measure because of the following reasons.

First, free time, or leisure is not included in GDP analysis.  While someone may be happier only working four days a week, that additional day off will reduce the GDP number.  While this makes sense because GDP is the measure of the total value of output, it shows us why using GDP as a measure of well-being or happiness doesn’t make sense.  It is possible to have a very industrious country have a very high GDP, but all of its people could be overworked and sick which would
translate to a poor well-being measure.

Next, GDP measures total production for a nation, and GDP per capita gives us an average amount of output per person, but it never tells us how GDP is divided among its residents.  Think of a corrupt nation, maybe the leaders of the government keep all of the money generated from production, and allow their citizens to live in slums.  Well-being could be very low even though GDP is high, because the majority of the products from that nation go to the elite.

Third, some services and products included in the GDP measure actually lower our well-being.  Imagine expenditures on the military, police, security and services for drug addiction and lawsuits.  Just because these services are being purchased, doesn’t mean that they improve our well-being.
Finally, GDP doesn’t take into account negative effects on the environment or other externalities.  When we produce goods and services, we use resources from the earth, and sometimes we pollute the air, water, and soil as well.  When trash goes into a landfill, this affects GDP positively because a service was purchased.  When oil is taken out of the ground, this counts positively towards GDP, but nowhere in this measure is it taken into account that the oil is now gone, and can never be used again.

How did world war 2 affect the US economy?   

Basically production of consumption goods shifted to production of military goods, however people were still paid for their labor.  Because they had less products to spend their money on, money was saved during this time period by everybody supporting the war effort.  After the war ended, there was a lot of idle capital (machines, factories, etc.) left from the war effort.  This idle capital was then used to create consumer goods, and since people had money saved from their efforts during the war, they had money to spend.  This encouraged GDP to grow after the transitions were made.

The difference between nominal GDP and real GDP is that nominal GDP is calculated using current values of the final goods and services while real GDP is calculated by designating a base year, and using prices from this base year to calculate the value of the final goods and services.  This difference allows us to account for inflation.  For example, if inflation is 3% per year, we would expect nominal GDP to rise 3% per year even if real GDP didn’t increase at all.  One drawback of using real GDP is that prices may rise at different rates relative to each other.  For example, the price of food may rise, but the price of computers will go down.  The further we are from the base year, the worse this measurement problem becomes.


Other measures for GDP include GNP (Gross national product), National income, personal income, disposable personal income, and division of income.

GNP measures the value of final goods and services produced by residents of a given country.  This means that production outside of a given country by its residents (for example, US residents living in the UK) still counts towards GNP.  GDP is a better measure for a lot of countries (including developing countries) because a lot of the capital is owned by foreigners. 

National income is the value of total income.  It differs from GDP in that it allows for depreciation of capital.  If we deduct this depreciation, we get a better measure of the income for the entire country (because depreciated parts have to be replaced and thus take away from total income).

Personal income measures the income received by households, and disposable personal income is personal income minus personal tax payments.  Finally we have division of income which shows where the income is going.  Income can flow to wages, taxes, profits, rent and interest among other things.

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