Discuss the drawbacks of GDP per head as an indicator of living standards and suggest what improvements might be made to produce a more useful measure.

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Discuss the drawbacks of GDP per head as an indicator of living standards and suggest what improvements might be made to produce a more useful measure.

The normal way of comparing the economic well-being of a nation or the individuals in the nation, is usually by using per capita income. This is the average income per head of the country. It is obtained by dividing the GDP (Gross Domestic Product) by the population. Using this method, the living standards between countries, and also living standards within a country overtime can be compared. However, there are a number of reasons why this may not be an accurate guide to measuring the living standards of a country, or the individuals living in the country.

Firstly, per capita income ignores the effects of inflation. If prices rise more rapidly in one country than in another, per capita income will be artificially inflated. In order to overcome this difficulty, money GDP can be deflated by the use of a price index, and by comparing the real per capita income, a better indication of relative living standards is deduced.

Secondly, real GDP does not include externalities. Externalities are third party costs which do affect living standards of the population, such as pollution and congestion. These pose costs on third parties and represent real opportunity costs for them, reducing their effective disposable income, and hence living standards. Pollution and congestion and other negative externalities also have negative effects on health. The time spent ill, is an opportunity cost to leisure, and furthermore, less days working reduces output.

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Furthermore, if real GDP per head is high, this may not be due to high wages, but due to long working hours. Long working hours result in less leisure time and stress, which reduces living standards.

Another reason why the real GDP may not be a good measure of standard of life is that the values that are shown up do not include quality of the goods. There may be increased output, but the goods that are being produced may be worse in term of quality, and thus the quality of life may not be improving. For example ...

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