Standard of Living and its Indicators Flashcards
Real GDP
The total money value of all final goods and services produced within a country’s geographical boundary during a given period of time, adjusted for inflation.
Real GDP= Nominal GDP - Inflation Rate
Gross National Income (GNI)
GDP plus factor incomes earned by residents overseas minus factor incomes earned by non-residents in the domestic economy.
Standard of living
Level of Material and Non-Material well-being of an individual and household.
Material SOL: Measures the amount of goods and services that individuals within the country have available for consumption.
Non-Material SOL: Measures the quality of life and involves intangible indicators such as amount of leisure, life expectancy, standard of education…
Limitations of GDP as an indicator of SOL
a) Measurement problems - an inaccurate measure of output
i) Non-market activities: Certain productive activities do not take place in any markets, where output is not traded for money. This includes DIY activities, voluntary work Etc… GDP overstates the actual increase in economic well-being as activities were produced previously but not included in GDP as they were not traded in the market.
ii) The underground Economy: Illegal and legal activities where income earned is not reported. Illegal activities occurs and understandably they also conceal their income. Some participants may engage in legal activities but choose not to report full incomes to avoid paying taxes.
These output mentioned are not included in a country’s GDP. The bigger the underground economy, the more inaccurate the GDP figure is in measuring the output and therefore a greater underestimation of SOL.
Using GDP to compare SOL OVER TIME
An increase in nominal GDP may not necessarily mean an improvement in SOL.
i) Price movements: an increase in nominal GDP may be due to an increase in general price level instead of output. Hence the rise in nominal GDP does not in any way reflect an improvement in the SOL of its people because the amount of G&S remains the same. Therefore, a better indicator would using Real GDP, to eliminate the effect of price changes. Any change in Real GDP therefore reflects changes in the total amount of output produced by the country and the extent of material wants satisfied.
ii) Population Changes: If Real GD doubles, it does not necessarily mean that the average citizen is able to enjoy twice as much than previously. This depends on the rate of population increase. Thus a more relevant measure of living standards would be real GDP per capita. Living standard falls if the percentage rise in population is greater than the percentage rise in the fall in real GDP, leading to a fall in real GNP per capita.
Using GDP to compare SOL OVER TIME: Gini Coefficient
Gini Coefficient measures the extent to which the distribution of income among individuals or households within an economy deviates from a perfectly equal distribution. Its value lies between 0 and 1.
0 reflects perfect equality, while 1 represents perfect inequality where one household has all the income and the rest has none.
Gini coefficient is calculated by the ratio of the area within the perfect equality line and the lorenz curve, over the area under the perfect equality line.
Rising real GDP figures coupled with rising Gini Coefficient reflects that the poor may not have benefitted from the economic growth and their standard of living may not have improved.
Using GDP to compare SOL OVER TIME: Other factors
i) Types of goods produced: Increase in production does not mean increase in consumption of goods as it depends on what type of good is produced. Producing more capital goods does not contribute directly to current economic welfare of its people as these goods do no directly satisfy human wants. Instead, they will increase future SOL as more goods can be produced then.
ii) Leisure: An increase in Real GDP, may occur because of greater productivity level of labour or the labour force is working longer hours.
If the latter is true, fewer hours for leisure is available. Leading to higher level of stress and medical problems and adverse social effects. The loss from reduced leisure could offset the gains from producing more and hence standard of living may not have improved.
iii) Quality of G&S: GDP estimates give the current market value of output of final G&S produced in a year. They do not reflect changes in the quality of G&S. Products may be safer, more durable or more useful. Thus, current GDP may therefore underestimate the welfare of residents.
iiii) Quality of the environment: As output increases, the quality of the environment may have deteriorated. The increase amount of by products from production such as polluted air and water, toxic wastes are external costs which are not deducted from the total output. GDP then overstates the well-being of residents in the country.
Using GDP to compare SOL OVER SPACE
It is a common practice to rely on real GDP per capita when comparing living standards of two countries.
Limitations of making international comparisons of SOL is the differences in exchange rates and cost of living
Difference in Exchange Rate: For any meaningful comparison of GDP between countries, it is necessary to convert GDP to a common currency such as the USD at current market exchange rate. However, if exchange rates fluctuates, the comparison using real GDP converted to a common currency may be less accurate, it becomes more difficult to compare SOL between countries since a rise in GDP is attributed to an appreciation of the domestic currency.
Differences in Cost of Living: Despite the conversion to a common currency, the market exchange rate may still not reflect the internal purchasing power of the country’s currency. Cost of living refers to the total amount of money required to maintain a specified SOL.
Thus, problem of differences can be solved by converting RNI at current market exchange rate to the Purchasing Power Parity exchange rate. At which the currency of one country would have to be converted into that of another country to buy the same amount of G&S. Using PPP is more accurate than current market exchange rate for converting GDP into a common currency. In conclusion, PPP- adjusted real GNI per capita is used to compare SOL over space.
Other indicators of SOL: HDI
Human Development Index: A composite index that takes into account achievements in three dimensions such as health, knowledge and standard of living.
Health is assessed by life expectancy, Education is assessed by mean years of schooling for adults and expected years of schooling for children, Standard of living is assessed by PPP-Adjusted GNI Per Capita.
Three basic dimensions included are thought that people’s welfare is influenced not only by goods and services available to them but also their ability to lead a long and healthy life and to acquire knowledge.
Other indicators of SOL: MEW
Measure of Economic Welfare (MEW): A measure that seeks to give a fuller picture of living standards by adjusting GDP figures to take into account other factors which have an impact on the quality of people’s lives.
MEW= GDP+ value of leisure + value of underground economy - environmental damage
Factors which improve living standards such as increased leisure hours are added to GDP figure, while factors which reduce SOL are also included.
While more direct and useful, MEW is difficult to compute simply because it is difficult to put a monetary value to leisure, recreation and pollution.
If there are alternative measures that are more holistic, why are GDP and GNI still the most commonly used measures?
Alternative measures are difficult to compute accurately because the value of leisure, non-marketed activities and externalities are difficult to estimate. In contrast, GNI per capita is relatively easy to calculate and statistics are available for most countries, allowing for more comparisons across space.
GNI per capita is also closely related to a country’s SOL, even though it may not be a perfect measure of SOL. Though it is not a measure of well-being, it is positively associated with many things people value like material SOL, health, long life expectancies, higher rates of literacy and etc… Generally, the higher the GNI per capita, the higher the country’s score on other indicators.
Thus, it remains the most commonly used measure of SOL since it is a comprehensive measure that is available on a regular basis.
