Measuring the Well-Being of Citizens
Gross Domestic Product (GDP) is an economic indicator that is used to measure the wellbeing of citizens in an economy. It examines the total monetary value of all goods and services produced within a country in a given period. Various approaches to measuring GDP have been widely applied in determining the welfare of an economy. However, several arguments have been advanced against the use of the gross domestic product as a reliable indicator of economic wellbeing. Based on the inadequacy of GDP as an indicator of welfare and progress in an economy, economists suggest the need to develop and apply other new measures of economic wellbeing (Taussig 2013, p.10). This essay will examine the appropriateness of GDP as a measure of individuals’ economic welfare using basic macroeconomic principles while referring to the United Kingdom. A government cannot solely rely on GDP as a measure of the well-being of its citizens.
Using Gross Domestic Product to Measure Progress and Wellbeing
In the United Kingdom, three approaches are used to measure gross domestic product (UNDP 2010, n.p). First is the use of production method which involves the value of final output in the economy after deducting the inputs utilized in the manufacturing process to avoid double-counting. In this case, it is only the value-added at each stage of production which is calculated and aggregated. For instance, the manufacture of a car as the final product, expertise, car tyres, and electricity only constitute intermediate goods. Therefore, the final output of a car tyre manufacturer is not included in calculating the value of the final output of a car (UNDP 2010, n.p). On the other hand, taxes and government subsidies are subtracted from the resulting gross value of the product to create a Gross Domestic Product.
Alternatively, the expenditure approach can also be used in calculating the gross domestic product of a country (Mattoo et al., 2006 p.22). A cost estimate is based on the monetary value of total expenditure goods and services produced in a country within a specified time. An array of data sources including surveys of household and business, government expenses and retail sales inquiry, among others are used in calculating the total value of expenditure. Similarly, to avoid double counting, the intermediate expenditure on goods and services are excluded in calculating the value of spending by corporations, government, consumers, and, oversea purchasers. Additionally, income approach is also used in the calculation of Gross Domestic Product in an economy. The income approach is derived from the wages and profits earned by individuals and corporations respectively. The sources of data used in calculating revenues include surveys on Average Weekly Earnings, employer surveys, and Quarterly Operating Profits among others (Taussig 2013, p.14). Notably, to come up with a reliable estimate, all the three approaches are reconciled.
Limitations of GDP as a Measure of Individual’s Welfare
Gross Domestic Product does not cover all facets of the economic well-being. The Economic welfare is analyzed based on the producer and consumer surplus. Demand curve (D) and Long-run Supply curve (S) can be used to explain this concept.
Diagram 1: Demonstrates the measuring of GDP
Source: Taussig, 2013 p.27
When production is at the equilibrium Qe the total sum of consumer surplus and producer surplus is given by the area ZEX. At this point when both consumer and producer surplus is maximized, a decrease in quantity produced, say Qe to q results into welfare losses. Consumer surplus is given by the region ZEP while producer surplus is given by the area XEP, which is the area above supply curve and below equilibrium price, P. When production of goods occurs at q, the distribution of welfare loss will be determined whether the commodities are offered at price R or Q. Consequently, at either price the deadweight loss remains the area NEM. Therefore, it shows that production approaches in calculating GDP do not consider the welfare losses that occur to both consumers and producers (Tausig 2013, p.28). On the other hand, Gross Domestic Products do not explicitly indicate whether growth that has occurred is based on the increase in production of goods and services or due to the increase in prices.
Moreover, Gross Domestic Product Per capita as employed in measuring wellbeing does not reflect the distribution of income in the economy (Frajman 2016, n.p). It implies that the per capita income deals with absolute averages thus cannot be used to indicate individual welfare due to the existing gaps. In this case, when income approach is used to measure GDP, the per capita income which is the total revenues divided by the entire population will not provide insight into the real purchasing power and living standards of the citizens. Since it is not clear whether the growth in GDP is contributed by the rich or the middle-income population, GDP per capita can grow while the productivity of an economy declines. As a result, the living standards and welfare begin to deteriorate when the government still focuses on the GDP. Concerning the distribution of income among the population, the curve is always negatively skewed, thereby, indicating that there are significant variations on the level of contribution towards the per capita income. In this case, only a few people say Y have higher income at N, while the greater part of the population either earns low or middle-level income. Attempts to explain the wellbeing of the whole population based on the average will not reflect the real picture of the economy as in the case of GDP per capita.
Diagram 2: Demonstrates the variations in per capita income
Moreover, GDP does not cover several aspects such as health, satisfaction, and quality of products that determine the wellbeing of the population in an economy (Frajman 2016, n.p). It implies that important aspects of human life that reflects on the living standards such as freedom and leisure are not captured since they cannot be quantified while measuring the Gross Domestic Product. On the other hand, harmful production methods that can lead to the emission of dangerous gasses from the factories will not be measured. On the contrary, if the government legislation ensures that there are expenditures incurred by the plant, then GDP will increase due to the spending. However, the welfare of those living close to the factory will still be compromised.
Furthermore, the calculation methods applied in measuring the GDP leaves out several important aspects (Frajman 2016, n.p). First, the legal, economic transactions that are not registered to evade taxation are always not captured. For instance, when commodities are exchanged with family members informally, they are not captured in the calculations of GDP. On the other hand, the black market activities such as the parallel economic activities are not reflected in the GDP. Such practices as prostitution and smuggling that occur within an economy do not form part of the calculations of GDP. Notably, the reduction in the stock of natural resources such as hunting fish in the sea or logging will indicate positive increments in the GDP even when they result in resource depletion and other forms of externalities (Stiglitz 2015, n.p). Notably, as the GDP is presumably increasing, the natural capital which determines the real economic welfare may be declining.
Finally, GDP involves some methodological problems in its calculation. In this case, it is noticeably difficult to measure government spending in the national accounts. Most of the public goods such as roads are freely provided or subsidized and the attempts to use price approach in establishing the value of these products results into unreliable data. For example, it will be difficult to explain the marginal benefit of street light to an individual. Therefore, using the total cost of production of these goods cannot indicate the welfare of the citizens absolutely. Also, the other aspects of wellbeing such as improved health conditions of the residents only reflect positively on the GDP when they become more expensive (Stiglitz 2015,, n.p). As a result, the cost and benefits of the healthcare system cannot be easily identified.
Following the inadequacy of GDP in measuring economic progress and wellbeing, there is the need to adopt Human Development Index (HDI) in determining the welfare of a nation (Stiglitz 2015, n.p). Both approaches can be used complementarily to achieve precision on the wellbeing of a country. Notably, HDI involves access to knowledge, standards of living and health status of the country. It requires the use of context-appropriate indicators such as educational attainment, lifestyle and social inequalities among other factors. It implies that when the level of individual earnings within an economy increases with increase in the health coverage that is healthy living, then economic welfare is said to have improved (Stiglitz 2015, n.p). Moreover, as the level of educational attainment increases alongside their earnings then their living standards are considered to improve leading to economic welfare.
Evidently, Gross Domestic Product is widely used in various countries including the United Kingdom as an indicator of economic progress and wellbeing. Its application involves the three approaches that are production, income, and growth estimates which majorly deals with the value of goods and services sold within an economy for a particular period. However, there are several disadvantages of using the gross domestic product as a measure of economic welfare. Among the outstanding arguments includes its inability to consider the distribution of income, externalities, and transactions in the parallel economy. Apparently, many countries have misrepresented the facts concerning the well-being of their citizens whenever they only use the GDP. It is also unfortunate that different nations compare their economic and social well-being by only taking into consideration the GDP. However, the concept is misleading as it is biased when applied to a population without much scrutiny. Therefore, GDP should be used together with other measures of economic welfare such as Human Development Index to effectively establish the growth in the wellbeing of an economy.
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