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GDP stands for Gross Domestic Product and is the total amount of output produced by an economy. There are 3 ways of measuring GDP and all should equal the same, although in reality some discrepancies mean this isn’t always the case.

There are 3 ways of measuring GDP; all are equal – the total production output of all businesses, the total incomes and profits in the country, or the total of all spending by individuals and businesses.

Problems with GDP

GDP is a common measure of how different countries are performing economically. It is a good measure as it is relatively straightforward and widely understood. It is also well established and is available for almost every country in the world therefore making it easy to compare income levels across countries. This can be done by dividing the population by GDP to get GDP per capita (per person). However it has its problems.

Exchange Rate Problems

Generally comparison of GDP occurs in $US Dollars. GDP is initially calculated in terms of local currency and then converted into US$ using the official exchange rate.

This is usually not representative of actual GDP as the exchange rate doesn’t necessarily take into account the purchasing power of the currency. One reason for this is due to government intervention. In LEDCSs currencies are usually pegged to an international currency – usually the US$. Therefore the exchange rate usually reflects government action and policy.

Where the exchange rate finds its own equilibrium level it is likely to be strongly affected by the price of internationally traded goods. To counter this PPP (Purchasing Power Parity) can be calculated which is designed to reflect the purchasing power of incomes more accurately.

When looking at PPP the gap between the low income and high income countries seems to be less distinctive than when GDP is converted to US$.

Inequality in Income Distribution

It has to be remembered that GDP per capita is the average income and not that every single person in the economy earns exactly the GDP per capita. This leads to inequalities in income distribution, meaning some groups of society have less money whilst others have more.

The Informal Sector and the Accuracy of Data

Another problem with international comparisons is that it isn’t always certain that the accuracy of which the data is collected is consistent. Definitions of GDP and other variables are now set out in a clear internationally agreed form but some countries may collect data more reliably than others.

An area where there is difficultly in gathering data is to do with the informal sector. In every economy there are some transactions that go unrecorded. This means it is hard to record these activities and so they are usually missed off GDP. This is especially prevalent in developing countries where substantial amounts of economic activity occur without an exchange of money. Bartering may be a method to remove the use of money and often in developing countries subsistence living remains an important factor in the lives of the population. If households are producing food for their own consumption then this will not be recorded as part of GDP whereas in developing countries food is usually bought and so is added to GDP.

Social Indicators

A final problem when using GDP is that it doesn’t take into account the country’s standard of living. Life expectancy, literacy rates and infant mortality rates are all important factors contributing to quality of life which isn’t taken into account by GDP.

It is also worth noting that GDP can be distorted due to environmental issues or natural disasters. For example an economy might grow by 5% but on closer analysis it may be due to a hurricane which destroyed many homes which had to be rebuilt. Even though this is technically growth it isn’t positive for the country and there isn’t MORE goods and services (there may even be less) they are just being replenished.

Page last updated on 20/10/13