Limitations of Real GDP

Limitations of Real GDP: Goods and Services Omitted From GDP

GDP measures the value of goods and services that are bought in markets, so it excludes:

  • Household Production : Household production is productive activities at the home that do not involve market transactions. As more services, such as childcare, meals and laundry are provided in the marketplace, the measured growth rate overstates development of all economic activity.
  • Underground Production : Underground production is the part of the economy that is hidden from the view of the government either because people want to avoid taxes and regulations or because the goods and services being produced are illegal. If the underground economy is a reasonably stable proportion of all economic activity, the growth rate will be accurate.
  • Leisure Time : Leisure time is an economic good that does not get measured in the official GDP figures. Increases in leisure timelower the economic growth rate, but we value our leisure time and we are better off with it. Increased output is not worth very much if we have little or no time to enjoy it.
  • Environmental Quality : Pollution does not directly lower the economic growth rate. If our standard of living is adversely affected by pollution, our GDP measure does not show this fact. The reason is that the devices that we produce to mitigate pollution count as part of GDP but the pollution itself is not subtracted. (1)

Limitations of Real GDP

Other influences on the standard of living omitted from GDP, but important for the standard of living, is:

  • Health and Life Expectancy : While obviously important factors determining the standard of people’s living, they are omitted from real GDP. Health and life expectancy have improved as infant deaths and death in childbirth have almost been eliminated. Life expectancy has increased from 70 years at the end of WWII to nearly 80 years today. These gains have been checked somewhat by AIDS and drug abuse, which take away from our standard of living.
  • Political Freedom and Social Justice : Political freedom and social justice are not measured by real GDP. A country might enjoy a very large GDP but have limited political freedom and social justice and, hence, have a lower standard of living. (1)

Self-Check Activity

Economic growth is a sustained expansion of production possibilities. Consider Table 3.4 and answer the question below. Click on the blank space to reveal the answer. (1)

Table 3.4: Differences in Economic Growth Rates

Year 3 percent growth rate 5 percent growth rate 8 percent growth rate
5 $115.92 $127.63 $146.93
10 $134.39 $162.89 $215.89
20 $180.61 $265.33 $466.10
40 $326.20 $704.00 $2,172.45

Do you think an economy will grow dramatically differently if the growth rate is 8% compared to 3%? (1) [Do you think an economy will grow dramatically differently if the growth rate is 8% compared to 3%?(1) Looking at the table, in the first 5 years the change is not substantial ($115.92 is not too different from $146.93), but in 20 years, and especially in 40 years the gap gets wider and wider, thus allowing for a country experiencing an 8% growth rate to have much higher GDP and income per person in 20 years (more than double) or 40 years (about 7 times higher).].