MAcro CHAPTER 2.2:

CHAPTER SUMMARY

It is really difficult to measure something as complex as an economy, so naturally, GDP and Real GDP are not perfect, magical, wonderful calculations. There are several limitations to using these calculations:

• Population: GDP often rises because our economy becomes more efficient. However, it can also rise simply because populations grow. For example, if our production of rice increases from 10 million kg to 11 million kg, our GDP might rise by 10% if this is representative of our whole economy. However, if this happened while our population increased from 1 million people to 2 million people, that means our population has increased by 100% (doubled), meaning that we used to have 10kg rice/person, but now we only have 5.5kg rice/person. Because of this, we also use a measure called GDP/capita, which is simply GDP divided by the number of people in an economy. This shows us if our economy is actually getting better at producing per person.

• Inequality: GDP only measures the total amount that we produce, but it does not measure who benefits from it. If two countries each have economies of 10 people with a GDP of $1 million, they both have a GDP/capita of $100,000. However, it is possible that Country A shares this equally and all people receive $100,000 of income, while in Country B, one person receives all $1 million of income while the other 9 live in extreme poverty. GDP would not capture this inequality.

• Externalities: GDP does not capture externalities associated with production and consumption. If a construction firm pollutes a local river while building a new apartment, this has no direct effect on GDP, as GDP only considers the market value of goods.

• Shadow Economy: The shadow economy - when people produce, buy, and sell things in a way that is not reported to the government - is also known as the black market or informal economy. GDP fails to capture things like drugs and other illegal products, or even otherwise legal products that are sold in illegal ways. It is very easy for the government to measure consumer spending when it is all done on credit cards, but much harder when it is done without any digital or even paper records - this makes it much harder to measure GDP in poorer or developing countries, where a larger part of the economy is informal.

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