Table of contents
1. Introduction
2. GDP as a measure of economic activity and well being
3. Problems which arise by comparing GDP across countries
4. Conclusion
5. List of references
1. Introduction
The purpose of this essay is to find out whether GDP (gross domestic product) is a good measure of economic activity and well being and which problems arise by comparing GDP across countries. The paper starts with a brief definition of the gross domestic product. Strengths and weaknesses of the GDP with respect to measuring of economic activity and well being will be discussed in the following. Next, the paper deals with difficulties which could occur by comparing GDP of different countries. Finally, a conclusion is given to identify the key findings of this essay.
Table of contents
1. Introduction
2. GDP as a measure of economic activity and well being
3. Problems which arise by comparing GDP across countries
4. Conclusion
5. List of references
1. Introduction
The purpose of this essay is to find out whether GDP (gross domestic product) is a good measure of economic activity and well being and which problems arise by comparing GDP across countries. The paper starts with a brief definition of the gross domestic product. Strengths and weaknesses of the GDP with respect to measuring of economic activity and well being will be discussed in the following. Next, the paper deals with difficulties which could occur by comparing GDP of different countries. Finally, a conclusion is given to identify the key findings of this essay.
2. GDP as a measure of economic activity and well being
“Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time”(Mankiw and Taylor, 2006, p.468). A very important part of this definition is the term ‘market value’. The difficulty is to compare different kinds of products such as cars and shoes. Hence, the contribution of each single product to the GDP is measured by its market price. This price also highlights the payment reserves of the costumers (Mankiw, 2012, p.494). To answer the question if GDP is a good measure of economic activity, it has to be clarified which predictable factors influence this activity and whether they are considered by GDP or not. Selling produced goods and services to the costumers is the main aim of all companies in an economy. These customers could be divided in four groups: households, firms, governments and the foreign sector (McDowell et. al., 2009, p.462). “Corresponding to the four groups of final users are four components of expenditure: consumption, investment, government purchases, and net exports” (McDowell et. al., 2009, p.463). Linking these expenditures with the GDP is crucial in order to identify whether GDP just highlights the produced goods and services or the real quantity requested by these user groups. Economists suppose that all goods and services being produced within a specified time will be in demand by at least one of the above named groups (McDowell et. al., 2009, p.463). As a result, the number of produced goods and services is equal to the number of demanded goods and services. Accordingly, the four groups of customers are the influencing factors of the economic activity. Hence, it would be interesting in what way these factors are considered in the GDP calculation. Generally, there are three methods of measuring GDP. One opportunity is to compute the total amount of spending on domestically produced final goods and services (Krugman, Wells and Graddy, 2007, p.586-587). This would mean the GDP equals consumption plus investment plus government purchases plus net exports (Sloman and Garratt, 2010, p.262). As a result, it is a perfect measure to highlight the economic activity of a country because it contains the four influencing factors in its calculation. Nevertheless, GDP is also criticized because it does not consider facts such as income distribution and the impacts for the environment by the economic growth (McDowell et. al., 2009, p.456). This leads to the question whether GDP is also a good measure of well being? Different opinions exist. Some analysts argue that it is a good instrument to gauge welfare because GDP per capita measures the income and expenditure of the average individual. As a result, it highlights the tangibles of an average person and could therefore be seen as an indicator of the living conditions in a country (Gans et. al., 2012, p.558). Nevertheless, it is just an indicator because no information is given about how the produced output is used to improve these conditions. Furthermore, this amount has no expressiveness about the quality of life (Therivel, 2004, p.86). For this reason, it is acknowledged that GDP is not a good criterion of well being (Wenzel, 2009, p.22). This could be highlighted by different examples. Economical damages such as air pollution and the destruction of the nature by the economic growth is not considered in the GDP calculation (Sherman et. al., 2008, p.462). Furthermore, childcare by mothers at home does not count although it contributes to the quality of life (Therivel, 2004, p.86). Indeed, accidents and breakups of families raise the GDP because they generate work for garages, breakdown services and lawyers (Landsberg, n.d., p.191). These examples show that, on the one hand, many social facts are not included in the GDP calculation and, on the other hand, events that do not contribute to human welfare raise the GDP. As a result, it could be confirmed that GDP is an indicator of well being at the most but not a measure to identify the quality of life or the welfare of the inhabitants of a country.
3. Problems which arise by comparing GDP across countries
When comparing the GDP across different nations, problems could arise because all nations have different basic prerequisites. For instance, they have always different numbers of inhabitants, different economical and ecological requirements and mostly different currencies (Fullbrook, 2007, p.218). To start with the problem of inhabitants, it seems probable that Luxemburg has a lower GDP than Germany. However, the GDP per capita in Luxemburg 2010 was more than twice as big as in Germany (European Commission, 2011). As a result, comparing total GDP between nations demonstrates only the dimensions of the economies but gives no information about the productivity of the inhabitants of this country. Accordingly, other measures such as GDP per head of the employed population have to be used to generate a convincing comparison of the average output of each worker (Sloman, 2006, p.375). This eliminates the problem of different numbers of workers at an economy and makes them more comparable. The second problem deals with the state of development of the different nations. Education, infrastructure, technology, mineral resources and political stability are only few treats (Djellal and Gallouj, 2008, p.121) which contribute to the productivity of the workers and, hence, to a high or low GDP. To differentiate developed from developing countries, economists mostly classify nations into First, Second, Third and Fourth World economies (Cryns, 2002, p.5). Accordingly, it makes no sense to compare just the GDP figures of two countries it also has to be clarified whether these two nations work at a similar economic level. Another problem which could arise by comparing GDP of different nations is the fact that almost all countries have different currencies. As a result, the amounts of GDP have to be transformed into an equal currency with the help of an exchange rate (OECD, 2011, p.14). Nevertheless, flawed figures could occur because the exchange rate does not consider the price level of each country (Siebert, 1999, p.102). This could lead to different GDPs even if both countries have sold equivalent products and services. Accordingly, the purchasing power parities approach which considers such price levels should be used to prevent this mistake (OECD, 2011, p.14). This highlights that not only the amount of the GDP is required but also the way of how this value is calculated.
4. Conclusion
In today’s complex business world it is very difficult to identify a measure which exactly highlights the activity of an economy and, additionally, the well being. The calculation of GDP includes the main treats of an economy. Thus, it is possible to make statements about its size. Nevertheless, it covers not all activities. Especially social factors are not recorded in this measure. By comparing GDP across countries some problems arise because it has to be adjusted at regional differences such as different currencies and different price levels. However, in connection with other measures it is definitely a good instrument to evaluate the economic performance of a country.
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- Quote paper
- MSc International Business Management with Logistics Thomas Bauer (Author), 2012, Is GDP a good measure of economic activity and well being?, Munich, GRIN Verlag, https://www.grin.com/document/205712
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