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Economic Theory

markets. In particular, GDP omits the value of goods and services
produced at home. When a chef prepares a delicious meal and sells it at his
restaurant, the value of that meal is part of GDP. But if the chef prepares
the same meal for his spouse, the value he has added to the raw ingredients

is left out of GDP. Similarly, child care provided in day care centers is part
of GDP, whereas child care by parents at home is not. Volunteer work also

contributes to the well-being of those in society, but GDP does not reflect
these contributions.
Another thing that GDP excludes is the quality of the environment.
Imagine that the government eliminated all environmental regulations.

Firms could then produce goods and services without considering the
pollution they create, and GDP might rise. Yet well-being would most
likely fall. The deterioration in the quality of air and water would more

than offset the gains from greater production.
In the end, we can conclude that GDP is a good measure of economic
wellbeing for most – but not all – purposes. It is important to keep in mind
what GDP includes and what it leaves out.

ASSIGNMENTS

Review Questions

1. Explain why an economy’s income must equal its expenditure.
2. What is difference between GNP and GDP?

3. Why must double counting be avoided when measuring GDP?
4. What are the approaches of measuring national income?
5. What is personal income and disposal income?

6. What is difference between real and nominal GDP? Why do
economists use real GDP rather than nominal GDP to gauge economic
well-being?

7. How to calculate real GDP?
8. What is GDP deflator?
9. How to calculate Per capita GDP?
10. What are the reasons why GDP should not be considered an

effective measure of the standard of living in a country?

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