National income statistics and comparisons of living standards

Overview

Gross domestic product and national income statistics understate living standards by omitting unpaid work.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What is gross domestic product, and what is gross national income?

   Model answer

   Gross domestic product is the total value of goods and services produced within a country's borders in a period, regardless of who owns the factors that produced them. Gross national income is the income accruing to a country's residents, which is domestic product plus income earned by residents from assets abroad minus income earned within the country by non-residents. The two differ most where foreign ownership of domestic production, or residents' ownership of foreign assets, is large.

2. 2

   Why can gross national income be a better measure of living standards than gross domestic product in a country with heavy foreign ownership?

   Model answer

   Domestic product counts everything produced inside the borders, including the output of foreign-owned plants whose profits are sent abroad and never become income for residents. Gross national income deducts that outflow, so it measures what residents can actually spend or save. In a country where multinationals operate large export facilities, domestic product can substantially exceed national income, and using the former would overstate how well off the population is.

3. 3

   Explain why national income figures must be expressed per head and in real terms before they can be used to compare living standards.

   Model answer

   Total income tells you the size of an economy, not the position of the people in it, so it must be divided by population to give income per head. Money figures must also be deflated by a price index, because a rise in nominal income that merely matches a rise in prices leaves purchasing power unchanged. Only real income per head measures the volume of goods and services available on average to each person, which is the quantity relevant to living standards.

4. 4

   A country has gross domestic product of 500 billion dollars and a population of 40 million. Calculate GDP per head and state what the figure does not tell you.

   Model answer

   GDP per head is 500 billion divided by 40 million, which is 12,500 dollars. It does not tell you how that income is distributed, so it is consistent with widespread poverty alongside great wealth. It says nothing about health, education, working hours, environmental quality or the value of unpaid and subsistence production, and it is affected by the exchange rate used to express it in dollars.

5. 5

   An economy's real output grows by 6 per cent in a year while its population grows by 2.5 per cent. Calculate the change in real output per head and comment on the method.

   Model answer

   Real output per head changes by a factor of 1.06 divided by 1.025, which is 1.0341, so it rises by 3.41 per cent. The rough method of subtracting the population growth rate from the output growth rate gives 3.5 per cent, which is a good approximation at low rates but overstates the true figure, and the approximation worsens as the rates get larger. The exact calculation divides the two index numbers rather than subtracting the percentages.

6. 6

   Real income per head in a country rises from 1,200 dollars to 1,800 dollars over ten years. Calculate the total percentage increase and the average annual growth rate.

   Model answer

   The total increase is 1,800 divided by 1,200, which is 1.5, so income per head rose by 50 per cent over the decade. The average annual growth rate is 1.5 raised to the power of one tenth, minus one, which is 1.0414 minus 1, or 4.14 per cent a year. Dividing 50 by 10 to get 5 per cent would be wrong, because it ignores compounding.

Other ways to work this

The same content, four other ways.

What is inside Levo

Six ways to work the same material.