Therefore, if we take GDP as a measure of welfare of the economy we shall be overestimating the actual welfare. There can be cases of positive externalities as well. In such cases GDP will underestimate the actual welfare of the economy. Fundamentally, GDP has several limitations because it does not consider intricate factors that determine economic status of a nation and economic welfare of populations.

GDP ignores the welfare component as the goods and services produced may or may not add to the welfare to a society. For example, the production of goods, like guns, narcotic drugs, high-end luxurious goods increase the monetary value of production, but they do not add to the welfare of the majority of population. Now, this line of argument seems a little too simplistic. Assuming causality based on a simple correlation between GDP and welfare may lead to false conclusions, which can be highly problematic, especially for policymakers. Hence it is important to look at the limitations of GDP as a welfare indicator and to consider possible alternative approaches. If increase in GDP is due to rise in prices and not due to increase in physical output.

The End of the Chinese Economic Miracle

However, such activites contribute to the economic welfare. Economic welfare depends less on the volume of goods and services are consumed, but more on what kind or type of goods and services are being consumed in the economy. GDP includes different types of goods and services such as houses, clothes, food, law and order, defense services, police services etc. Utility of a unit (one rupee or one dollar) of income is more to the poor than the rich. Suppose, the income of the poor declines by one unit and that of the rich increases by one unit. In this case, decline in the welfare of the poor will be more than the increase in welfare of the rich.

Gross Domestic Product (GDP) is an economic parameter that measures economic activity of a nation. Conventionally, GDP measures the market value of goods and services that a nation produces in a given time in terms of per capita. The increase in aggregate national income may be a result of the increase in income of a few individuals. Thus, this may lead to false interpretation of social welfare. As mentioned before, GDP only describes the value of all finished goods produced within an economy over a set period of time.

Limitations of GDP as a measure of welfare Class 12

These are left on account of non availability of data and problem in valuation. Household work—including childcare, cooking, cleaning, and home maintenance—creates substantial economic value but remains invisible in GDP calculations. When a parent stays home to raise children, their contribution registers as zero in GDP terms. If the same parent hired a nanny, that service would count toward GDP—even though the actual economic value provided might be similar.

Social Progress Index

Perhaps one of GDP’s most significant blind spots is its inability to reflect how income is distributed throughout society. A country might boast impressive GDP growth while the majority of citizens experience stagnant or declining living standards. This short video looks at some of the limitations of GDP when measuring changes in economic well-being. Write down some of the limitations of using GDP as an index of welfare of a country. It means the income of rich people rises by many folds than the common man.

Quality versus quantity of goods and services 🔗

Overall GDP would seem to rise, but richer are getting richer, poorer are getting poorer. Such as, consumption level, types of goods and services consumed, environmental pollution and law and order situation etc. In the light of the given statements, choose explain the limitation of gdp as welfare. the correct alternative from the following. Key demand of the questionCritically analyze why GDP fails to measure welfare effectively and suggest indices that address these shortcomings comprehensively.

• Therefore, if we take GDP as a measure of welfare of the economy we shall be overestimating the actual welfare.
• Suppose, the income of the poor declines by one unit and that of the rich increases by one unit.
• “Many goods and services which may contribute to welfare, but are not included in estimating Gross Domestic Product (GDP).”
• GDP treats all economic activities equally, regardless of whether they enhance or diminish welfare.
• But the flyover, reduces the transport cost and journey time to those who have not contributed into its construction.

It will not be a reliable index of economic welfare. Therefore, How much is the economic welfare depends on the types of goods and services produced not how much is produced. So, if we only depend GDP as the measure of economic welfare.

In many developing countries, the informal economy represents a substantial portion of economic activity. Street vendors, day laborers, and small-scale farmers operating outside formal markets contribute to economic welfare but often remain uncounted in official GDP statistics. GDP only captures economic activities that involve monetary transactions in formal markets. This systematic blindness to non-market activities creates significant distortions in welfare measurement. Since many goods and services are not present in markets, use of GDP as an indicator of economic welfare of the population gives an underestimated value of welfare status. Rationale of using GDP as a welfare indicator has it basis on the assumption that economic activities directly indicate economic welfare of citizens.

• However, it fails to account for the costs of lost biodiversity, carbon sequestration capacity, soil erosion prevention, and other ecosystem services that forests provide.
• Rationale of using GDP as a welfare indicator has it basis on the assumption that economic activities directly indicate economic welfare of citizens.
• Hence it is important to look at the limitations of GDP as a welfare indicator and to consider possible alternative approaches.
• But there are many reasons it is not an adequate measure of it.
• In such a situation, a rise in the GDP does not enhance the economic welfare.

Riesman (2006) argues that, GDP examines the value of final products and thus exclude value of intermediate products or raw materials that are economically significant (p. 611). GDP measures the goods and services produced in an economy during a particular period of time. However, it does not take into account those transactions that do not come under monetary terms. In less developed countries there are non-monetary exchanges, particularly in rural areas. Hence, these transactions remain outside the domain of GDP. The household sector and volunteer sectors get ignored in GDP.

150 MCQs of National income chapter class 12 CBSE Board

Kahneman and Krueger (2006) argue that, economic activities of a nation and economic welfare of individuals are technically different entities that coincidentally correlate (p.6). Thus, it is assumptive to believe that GDP correlates with economic welfare of populations. While GDP can provide a snapshot of economic activity, it doesn’t fully capture the quality of life of a population or the sustainability of economic growth. 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 the Human Development Index (HDI), the Gross National Happiness Index (GNH), and the Social Progress Index (SPI). Gross Domestic Product (GDP) is essentially an indicator of aggregate economic activity.

If rate of population growth is higher than the rate of GDP. But not the positive externalities such as reducing transport cost and journey flowing out of it. For example, construction of a flyover results in flow of goods and services and counted in GDP. But the flyover, reduces the transport cost and journey time to those who have not contributed into its construction.

Welfare means sense of material well being among the people. This depends upon greater availability of goods and services. So it may be concluded that higher level of GDP is an index of greater well being of people.

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