Gross Domestic Product and Welfare
Gross Domestic Product (GDP) is the monetary value of final goods produced within the domestic borders of a country in a year. GDP is considered a measure of a country's progress. If wealth accumulates in the hands of a certain group of people in the economy due to an increase in GDP, this can lead to inequality. Social costs such as air pollution and water pollution caused by an increase in GDP also negatively affect the welfare of the people.
Relationship Between GDP and Welfare
A high GDP of a country is considered an indicator of the high welfare of the people of that country. This assumption is not entirely correct. Some of the reasons for this are as follows.
■ Inequality in GDP distribution
As GDP increases, inequality may also increase. The increase in GDP is concentrated in the hands of some individuals or production units. The income of a small minority may increase significantly while the income of the majority may decrease.
■ Non-monetary transactions
Many activities that take place within an economy cannot be measured in monetary terms. Housewives' services and barter transactions (exchange transactions without using money) are non-monetary transactions that are not included in GDP. Therefore, GDP is not adequate to measure the real income or welfare in an economy. In a country like India with a large population and non-financial sectors, GDP is undervalued.
■ Externalities
Externalities are the effects of one producer or individual on another without any compensation. Externalities can be beneficial or harmful. Externalities are not something that can be bought or sold in a market.
Real GDP and Monetary GDP
It is not possible to rely on GDP measured at current market prices to compare GDP values of different countries or to compare GDP values of a country at different periods. Real GDP is used to help in such comparisons. Real GDP is obtained when GDP is calculated at Constant Prices. When GDP is calculated based on Constant Prices, the fluctuations in it depend entirely on production. Monetary GDP is calculated at Current Prices.
The ratio between monetary GDP and real GDP gives an idea of the change in prices from the base year to the current year. Real GDP is calculated using the prices of the base year. The ratio between monetary GDP and real GDP is a well-known index of prices. This ratio is the GDP Deflator. If Monetary GDP is referred to as GDP and Real GDP as gdp,
GDP Deflator = GDP/gdp
In some cases, GDP Deflator is also stated as a percentage. When so indicated,
GDP Deflator = GDP/gdp x 100
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