Why GDP or GNP is regarded as very good indicator of economic welfare?

Why GDP or GNP is regarded as very good indicator of economic welfare?

GNP estimates are more commonly employed as an indicator of economic welfare. An increased output of goods and services, it is believed, implies an increased availability of goods and services for consumption, enabling a wider choice and a better standard of living; these are the hallmarks of economic development.

However, this simple positive relationship between increase in GDP and increase in economic welfare is subject to certain qualifications. Among these, the following are noteworthy:

Changes in the Size of GDP and Economic Welfare :

If the GDP increases but the population of the country increases in a greater proportion, the total economic welfare will decline. As a result of increased population, the per capita income will decline, which means lesser purchasing power than before, lower standard of living, and consequently, lower economic welfare.

While analysing the relationship between the size of GDP and economic welfare, the behaviour of the price movements must be thoroughly studied.

GDP calculated at current prices is always deceptive and increase in its size, will not promote economic welfare. Estimates of real GDP (i.e., GDP calculated at fixed base prices) can provide a better measure.

GDP consists of those goods and services which are transacted in the market and fetch money value. We know that a part of the total produce is kept by the producers for self-consumption.

Now, suppose that this retained produce (which is not part of GDP) is offered for sale in the market, it will definitely fetch money value and as a result GDP will also increase.

In fact, the total output is same, but since it has now come to the monetary sector, it becomes a part of the GDP and hence increases its value. Such an increase in GDP wills the economic welfare.

If the increase in the size of GDP is the result of prolonged working hours, increased employment of children in production, unhealthy and polluted atmosphere inside the factory premises, and such increase in GDP will not promote or be symptomatic of economic welfare.

Changes in the Composition of GDP and Economic Welfare:

Composition of GDP refers to the kinds of goods and services produced in an economy. Changes in the composition of GDP may sometimes increase economic welfare and may at other times decrease it. Let us consider the following cases:

If the total production has increased on account of more production of capital goods, it will not increase economic welfare.

No doubt the money value of the total output has increased, but the volume of consumer goods, on which depends the real economic welfare, has not increased. It is only when the proportion of consumer goods increases in the total output the GDP can promote economic welfare.

If the GDP has increased on account of larger production of war-goods, the resultant increase will not increase economic welfare. This may no doubt lead to increased lighting capacity of the country but it will do no good to economic welfare.

Changes in the Distribution of GDP and Economic Welfare:

If the GDP increases and yet is not fairly distributed or it is concentrated in a fewer hands, it will not promote economic welfare. It is so because as the rich people get richer the additional money income does not provide them the same marginal utility as the preceding unit of money income.

In other words, the law of diminishing marginal utility also applies to the additional money income so that the economic welfare instead of increasing will diminish.

When the distribution of GDP changes in favour of the poor, they start getting more commodities and services than before; as a result the economic welfare increases. Any transfer of income from the rich to the poor, generally, promotes economic welfare.

In fact, there is a unique relationship between one’s economic welfare and that part of this income which lie spends on consumption and consequently smaller is his economic welfare compared to this total income.

The poor people who spend a major proportion of their total income on consumption, as a matter of fact, will get larger utility from the transferred income as compared to the rich people.

Transfer of income from the rich to the poor, however, does not increase economic welfare always, especially if additional income in the hands of the poor gets frittered away on such things as simply reduce their welfare.