Why might a given increase in real GDP not accurately reflect an increase in living

standards?

In brieI, measuring the Gross Domestic Product (GDP) oI a country is a way oI calculating
economic activity in the region. There are three ways a government can take the GDP oI its
country; by measuring the monetary value oI its income, output or expenditure. However, the
value oI the normal nominal GDP` depends on not only the actual quantity oI goods but the prices
oI goods as well, and this can largely be aIIected by inIlation or deIlation. ThereIore, adjustments
are made to the nominal GDP based on price changes to make the real GDP`, a more accurate
measure oI economic activity. It is a common misconception that the real GDP is an indicator oI
not only economic well being but also oI standards oI living. UnIortunately, inIlation and deIlation
are not the only reasons why the GDP might not reIlect how a society is Iaring and even real GDP
might not indicate actual standards oI livings in a country.

The reported growth in real GDP largely depends on the government and the accuracy oI their
statistics and calculations and even iI a government is extremely careIul in their data collection and
calculations, there will be economic activity that will not be measured. Shadow economies, also
known as underground economies or black markets, are extremely prominent especially in
countries in which production taxes are high. Markets in these economies do not declare their
economic output usually either to avoid being taxed or because its goods have been banned. II
there are markets that the government are not aware oI and thus cannot measure, the real GDP that
the government declares will not be accurate. OIten there is also non marketed output in an
economy, where there is no oIIicial transaction between suppliers and consumers and thereIore, no
record oI economic activity. For example, iI a person cuts Iirewood and gives some Iirewood to his
Iriend. There is still a transition oI goods Irom suppliers to consumers but it is not oIIicial or
recorded and there are oIten no prices on part oI the consumers. Similarly to the consequences oI a
shadow economy, iI economic transactions are not recorded and declared, the government cannot
report an accurate representation its country`s economic activity.

Real GDP also does not take into account the composition oI output, only the monetary value oI it,
and also disregards its region`s purchasing power parity (PPP) compared to other regions.
Measuring output based on its prices is a problem simply because an expensive good might not
represent a useIul good. In Iact, many expensive goods are luxuries while some goods with less
monetary value are needs. It is possible that a country has a high real GDP value, perhaps due to its
specialisation in luxury items, and yet also has substandard living conditions because oI lack oI
output in necessities. On the other hand, another region could have a low GDP and but good living
conditions because the necessities oI its citizens are met. Countries with a relatively low GDP can
also have higher standards oI living than countries with higher GDP because oI diIIerences in PPP.
Purchasing power parity is an equilibrium at which the price oI a good in one region is the same as
the price oI the same good is in another. Sometimes, exchange rates between countries do not
reIlect the PPP and so it is cheaper or more expensive to buy certain goods and services in certain
countries. For example, the GDP oI the United States (in 2010) was 14,620,000, almost three times
that oI China, but the price oI a Big Mac hamburger in China is less than halI the price oI a Big
Mac in the United States. Even more shocking is the diIIerences in the prices oI taxi rides. The
price oI a taxi ride in Los Angeles can be up to Iive times more expensive than a taxi ride oI the
same length in Beijing, depending on the distance traveled. Naturally, in a region in which living
costs are relatively lower than other regions, a lower real GDP does not indicate lower standards oI
living.

In addition, a growth in real GDP might not reIlect a rise in living standards because the GDP also
does not take into account the population oI the region or the income disparity. It is not by
coincidence that the two countries, namely the U.S. and China, with the largest populations have
the highest GDP. That there will be more economic activity in regions with more people than in
regions with less people is to be expected. A more accurate representation oI a country`s living
standards would be iI the GDP was then divided by the region`s population to make the GDP per
capita. Unsurprisingly the countries with the highest GDP per capita are not the U.S. or China, but
Qatar, Liechtenstein, Luxermbourg and Norway. However, even then, a high GDP per capita
might not reIlect high living standards in the country depending on the income disparity. For
example, China has a real GDP growth rate oI 10.1 per cent which is very high considering its
large population. Yet, China has only medium human development` according to the United
Nations and more than 212 million people are living below US$1.25 a day. Here it shows that the
Chinese government has not redistributed income among its citizens and that China`s capitalist
economic policies and many corrupt oIIicials stop the nation`s growth in wealth Irom being shared.
China`s rise in real GDP has not so Iar reIlected a correlating rise in standards oI living Ior every
citizen.

Finally, there is also the notion that 'money cannot buy happiness. The real GDP is a measure oI
the economic and thereIore monetary growth and activities. The amount oI money and the material
goods owned are determinants oI living standards, as are stress levels, health, crime rates, political
Ireedom and countless oI other externalities. Surveys have shown that though the purchasing
power oI the average Hong Kong citizen is higher than that oI an average European citizen, the
average European citizen is more content with his liIe than the average Hong Kong citizen,
because oI the long working hours and high stress levels in Hong Kong. Some say that the real
indicator oI standards oI living is the level oI satisIaction with a person`s own liIe, not GDP. As
Robert F Kennedy says, the GDP 'measures, in short, everything except that makes liIe
worthwhile.

In conclusion, a growth in real GDP might not accurately reIlect a rise in living standards Ior
numerous reasons, some oI which are demonstrated above, thus the GDP should not be used to
judge human development.
Munglok Wong 12 LZ
Economics HL: Mr. Parkinson