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How is GDP measured and what are its limitations as a measure of the quality of life?

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Gideon Krotosky Macroeconomics coursework Spring 2004 EC1001 Lecturer- John Heaman Tutorial - Peter Wilks BSc Economics and Accountancy Q. How is GDP measured and what are its limitations as a measure of the quality of life? A. Gross Domestic Product (GDP) can be defined as the annual value of output produced by factors of production within a nation's border. In other words, it is the sum of all incomes earned by the country's residents when producing goods and services with resources located inside that country. GDP is not to be confused with Gross National Product (GNP), which measures the flow of output produced with resources, which are owned by the nation wherever they might be located. The difference between GDP and GNP is net property income from abroad. The word "gross" in both of these measures of national income, indicates that no account has been taken of depreciation. There are 3 methods of calculating GDP: the product/output method, the income method and the expenditure method. In theory, because they all claim to measure the same aggregate, they should all give the same total. This is shown below in the circular flow of income: However, in practice, this is unlikely to be the case. This is because extremely large sums arising out of millions of transactions paid over different time periods are being dealt with and it would therefore be very unlikely if all 3 measures coincided. ...read more.


As a result of this, it is deducted. The main adjustments for the expenditure method include: * Taxes and subsidies - the expenditure total is adjusted to factor cost by deducting indirect taxes and adding subsidies. This is done in order to avoid a discrepancy between the income and expenditure totals. Indirect taxes raise total expenditure on goods and services relative to the amount received by the factor of production, and subsidies have the reverse effect. * Additions to stock and work in progress - these represent investment. The factors of production, which have produced this unsold output, will still have received factor payments. By ignoring additions to stock and work in progress, an imbalance between the 3 aggregates of output, income and expenditure would have been created; therefore, additions to stock and work in progress are treated as though firms have purchased them. Great interest is attached to measured values of GDP. Governments, investors and citizens gauge the success of their economies by how its GDP changes over time. Movements in the national income are often used to indicate changes in the quality of life but care must be taken in using figures for this purpose. It has many limitations: (1) Economic bads and externalities: some of the undesirable effects of economic growth may actually increase GDP. ...read more.


Highlighting internal disparities along these lines has raised national debate in many countries. In my opinion though, the HDI alone is not enough to measure accurately a country's level of development or its quality of life. This is because the concepts of human development and quality of life are much broader than what can be captured in the HDI. The HDI, for example, does not reflect political participation and regional or gender inequalities. HDI and the other composite indices only offer a broad proxy on the issues of human development, gender disparity, and human poverty. A fuller picture of a country's level of human development and its quality of life would in my opinion requires the analysis of the HDI in conjunction with a combination of other development indicators and information. In contrast to the use of HDI measuring living standards, GDP cannot be used to measure human development because of the HDI because it only reflects average national income. It tells nothing of how that income is distributed or how that income is spent - whether on universal health, education or military expenditure. Comparing rankings on GDP per capita and the HDI can reveal much about the results of national policy choices. For example, a country with a very high GDP per capita such as Kuwait, who has a relatively low level of education attainment, can have a lower HDI rank than, say, Uruguay, who has roughly half the GDP per capita of Kuwait. ...read more.

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