3 GDP AS A MEASURE OF WELFARE

PRINCIPLES OF

MACROECONOMICS

N. G R E G O R Y M A N K I W

PowerPoint® Slides
by Ron Cronovich

© 2007 Thomson South-Western, all rights reserved

In this chapter, we will be able to know-

 Topics covered:
 GDP as a Measure of Welfare
 Alternative Approaches to Measure Welfare

2
 Introduction

 GDP AS A MEASURE OF WELFARE

 Economic welfare is comprehensive measure of the

general state of economic well- being.
 Economic welfare improves when production of all the
goods and services grows.
 However, the growth of real GDP does not provide a full
and accurate measure of the changes in economic
welfare.

3
 GDP AS A MEASURE OF WELFARE

 Limitations of the GDP Concept

1) Over adjustment for inflation

2) Household production
3) Underground economic activity
4) Health and life expectancy
5) Leisure time
6) Environment quality
7) Social justice.

4
 Limitations of the GDP Concept:
1) Over adjustment for inflation

• The price indexes used to measure inflation give us an

upward –biased estimate of true inflation.
• If we overestimate the rise in prices, we underestimate
the growth of real GDP.
• For example, when car prices rise because cars have got
better features like safety, fuel efficiency, better comfort
etc. the CPI and the GDP deflator may count the price
rise as inflation.
• So what is really an increase in production is counted as
an increase in price rather than an increase in real GDP.
5
 Limitations of the GDP Concept:

2) Household production

• An enormous amount of production takes place every day

in our homes.
• They are all productive activities that do not involve
market transactions and are not counted as part of GDP.

6
 Limitations of the GDP Concept:

3) Underground Economic Activity

 The underground economic activities are purposely
hidden from the view of the government in order to avoid
taxes.
 These goods are illegal and not reported.
 Thus, it is omitted from GDP.

7
 Limitations of the GDP Concept:

4) Health and Life Expectancy

 Good health and a long life – the hopes of every one – do

not show up in real GDP.
 Increase in real GDP over the years has increased our
life expectancy.
 However, we face new challenges like AIDS and drug
abuse.
 If we take these negative influences into account, we see
that the real GDP growth overstates the improvements in
economic welfare.
8
 Limitations of the GDP Concept:

5) Leisure Time

 Leisure Time
 Leisure time is an economic good that adds to our
economic welfare.
 Other things being equal, the more leisure we have, the
better off we are.
 Our working time is valued as part of GDP, but our leisure
time is not. Over the years, leisure time has steadily
increased,
 But these improvement in economic well-being are not
reflected in real GDP.
9
 Limitations of the GDP Concept:

6) Environment Quality

 Economic activity directly influences the quality of the

environment.
 The depletion of exhaustible resources, the mass clearing
of forests, and the pollution of lakes and rivers are other
major environmental consequences of industrial
production.

10
 Limitations of the GDP Concept:

7) Inequalities

 Inequalities
 A country might have a very large real GDP per person,
while it is distributed inequitably where small elite enjoy
vast wealth and the big majority live in abject poverty.
 Such an economy would generally be regarded as having
less economic welfare than one with more equitable
distribution of income.

11
ALTERNATIVE APPROACHES TO MEASURE WELFARE

 In view of the shortcomings mentioned above there have

been various attempts to develop more accurate and
reliable indicators in order to measure social well-being.
 Among others these alternative approaches include
following approaches-
1) Human Development Index (HDI),
2) Gross National Happiness Index (GNH), and
3) Social Progress Index (SPI).

12
ALTERNATIVE APPROACHES TO MEASURE WELFARE

1) Human Development Index:

An indicator that focuses specifically on people and their
capabilities to assess the development and welfare of a
country.
In particular, it measures achievements in three critical
dimensions:
• Health and life expectancy,
• Education,
• Standard of living.

13
ALTERNATIVE APPROACHES TO MEASURE WELFARE

2) Gross National Happiness Index:

An index that takes a holistic and psychology based
approach to measuring social welfare.
It was developed in Bhutan and builds on four pillars:
• Governance,
• Socio-economic development,
• Cultural preservation,
• Environmental conservation.
This index gives better result in measuring welfare.

14
 ALTERNATIVE APPROACHES TO MEASURE WELFARE

 3) Social Progress Index: An extensive framework that is

based on three key dimensions: basic human needs,
foundations of well-being, and opportunity.
 Again, social progress for each of those dimensions is
measured by a multitude of indicators.
Those include: 
• Nutrition,
• Medical care, and safety (basic human needs), education,
• Wellness, and sustainability (foundations of well-being),
and
• Personal rights, freedom, and tolerance (opportunity).

15
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS 16
CHAPTER 3 GDP AS A MEASURE OF WELFARE

REVIEW QUESTIONS

1) Explain the limitations of GDP as measure of welfare.

2) What are the alternative approaches for measuring welfare?

17
 REFERENCES

 https://ebookcentral.proquest.com/lib/shctom/
detail.action?
docID=346118&query=macro+economics
 https://ebookcentral.proquest.com/lib/shctom/
detail.action?
docID=1144063&query=macro+economics

18