The inaccuracy of the calculation of GDP using the income method is equally as observable because of some problems in using it. First of all, transfer payments, which are not payments for productive services, should no be included in the addition of incomes, for example, pensions, unemployment, and child benefit. Also, some people do work and receive incomes that are not declared to the government, like babysitting and house cleaning. Therefore, the money received by these people isn’t counted into the national income addition. Just like stock appreciation, since stocks vary in price an average annual value has to be estimated to use in the calculation. Although the expenditure method is the most accurate way of calculating GDP, it is the most complicated. The differentiation between an income and output is hard to determine because most money flows back and forth between the two.
After the GDP per capita figure is calculated it can be used to compare living standards between countries. Although it is a relatively accurate figure there are some limitations and problems to using it in this manner. That is why we can make an educated guess, but not a totally accurate assumption of the higher living standards in Stephatania compared to Merksland. First of all, GDP is a gross measure of output and doesn’t take into account the ownership of economic resources and replacement investment taking place because of the consumption of capital goods. Inflation must be known to make a comparison over time, although this is not necessary for comparisons between countries, it will give a more accurate figure, real GDP per capita.
Exchange rates, on the other hand, are necessary for comparing two country’s’ GDP. There needs to be a common currency to be able to compare accurately, usually in US $ or Euros are used. In converting to a common currency, the exchange rates used could distort the comparisons if they do not reflect the purchasing power of two currencies. This is the amount that can be bought for a set amount of money in both countries. The exchange rate used may not reflect differences in price of goods therefore the Purchasing Power Parity should be used to give a more accurate comparison.
Again, incomes and outputs that aren’t declared to the government aren’t put into the GDP calculations and potentially inaccurate estimations have to be made. Like the black or parallel economy, it varies in size between countries and therefore these estimations might distort the comparisons between the countries. Imputed values are counted into GDP calculations to make up for the self provided goods and services that cannot be counted. The GDP does not take into account the economic infrastructure of each country. Countries all have a certain amount of social capital already existing in a country, like roads, airports, electricity, water supply and hospitals, these could affect the living standards of countries and GDP doesn’t cover those figures.
Distribution of income and wealth has to be regarded in comparison of living standards, and the GDP per capita figure does not do this. If a country has a relatively high GDP but only a small minority of the population has a high percentage of the national wealth, then a great percentage of the population has a low annual income. Since GDP per capita is an average figure it will increase the income of the poor people and decrease the income of the rich people. So the country may have a higher GDP per capita than most of the population actually has, making their living standards seem higher than they are. Lorenz curve displays this theory:
Countries have a choice about what to spend their GDP on, for example, civilian goods, like public or merit goods, and military goods. These civilian goods bring a higher standard of living and help the people of the country. When a country spends more of their GNP on military goods, less is spent on civilian goods and therefore lowers the standard of living compared to a country, for example, at peace who only spends 10% of their GNP on military spending and the rest on civilian goods.
Some Scandinavian countries have a high tax rate on incomes for the government to spend on public and merit goods, making these goods at a lower price than in countries with low tax rates. This method also increases the standard of living for a country. To take in account this method of taxation economists use the Real Disposable National Income per Capita to measure living standards. Another thing that could create limitations on using GDP per capita for living standards is the fact that collecting statistics is difficult to do, especially in LDC’s because of lack of communication possibilities therefore making their measurements even less accurate.
There are many ways to determine living standards of a country and it all depends on the economist and what they think are important measures to consider. This makes it hard to put an exact “value” on many of these standards. For example, externalities, like pollution, traffic, stress, and drugs. A disadvantage to having a higher GDP per capita are the spill over effects to the country’s living standards, people suffering drug addiction bring negative externalities and lower the quality of life. From person to person, it varies what makes a place a good place to live, like climate, freedom, position of women, and population density.
This is why there are two other indexes of living standards, the Human Suffering Index and the Human Development Index. The H.S.I. uses ten indicators of human well being like life expectancy, daily calorie supply, access to clean water, infant immunization, secondary school enrollment, per capita income, rate of inflation, communications, technology, political freedom and civil rights. According to this method counties like Denmark have the highest living standards, and countries like Mozambique have the lowest. The H.D.I. is another indicator that combines life expectancy, literacy and purchasing power into a measure. This measure proves that a higher GDP per capita does not mean a higher standard of living. Algeria, for example, has a higher GDP per capita than Sri Lanka; while according to the H.D.I. Sri Lanka has higher living standards.
From these examples we can see that higher living standards do not necessarily come from a higher GDP per capita. There are many faults in calculating GDP, and in using GDP per capita to compare living standards between countries. Therefore, it is not a perfected measure to give an exact statement saying a country has higher living standards than another. Therefore, the answer to the question, with support from the above, is that no, Stephatania might not have a higher standard of living than Merksland because it has a higher GDP per capita.
