Limitations of GDP | Economic indicators and the business cycle | AP Macroeconomics | Khan Academy

In other videos, we have already talked about the idea of GDP in some depth—gross domestic product, a measure of the aggregate goods and services produced in a country in a year. But what we're going to discuss in this video is how good a measure GDP is, and in particular, some of the things that GDP does not measure.

So in general, what's the motivation for wanting to know the aggregate goods and services produced by a country? Well, you could view it as a sign of economic activity—so it's economic economic activity. You could view it as the size or influence of an economy—size, influence of economy. And then if you take GDP and you divide by the number of people in a country, you get things like GDP per capita. GDP per capita we could view really as GDP per head, and this you could view as well—that's an indicator of well-being—with the idea that, well, if there's just more goods and services produced per person, then maybe people in that country are going to be better off.

But as we already touched on, what is it not measuring? Well, one thing that GDP does not measure is non-marketed goods. What do I mean by non-marketed goods? So let's say that I have to go to the airport. So this is the airport here—my best drawing. It's a terminal, there's a plane—that's the point of this isn't to draw an airport, but you get the idea, that's an airport. And I need to go from my house to the airport. If I call up a taxi or an Uber or Lyft or something like that, and I take it to the airport, so they drive me to that airport. That fare that they charge me will be included in GDP.

On the other hand, if I were to get my wife to drive me to the airport, all of a sudden that would not be counted in GDP, even though the exact same service has been performed—someone took me in their car from my house to the airport. And that's because my wife, or your roommate, or your best friend giving you a ride is a non-marketed service. They're not trying to sell that service; they're just doing that to you as a favor. But it was a service provided to you, but it would not be captured in GDP.

One that is often talked about is child care. If that's my best drawing of a child, really fast—if you hire a babysitter, or if you hire a nanny to take care of your child, that should be included in GDP. Although if you yourself take care of your child, that will not be included in GDP because, once again, you taking care of your child would be a non-marketed service.

Now, the other thing that GDP does not include are illegal activity, or you could even say under the table activity, some of which is not illegal. For example, if someone were to pay their babysitter, and if it doesn't get registered in taxes someplace, well, even that will not be reflected in the GDP number. It's not an illegal activity, but it should have officially been registered with the IRS, and then it would have been counted as GDP. But in this case, it wouldn't have. And also, of course, you have black markets; illegal activity that for sure would not be included in GDP. If someone were to illegally sell you fireworks, let’s say they're banned in your state, and of course they're not going to report it to the government, well of course that good and/or service is not going to be reflected in GDP.

But you might say, "Okay, that's all right, you're going to miss some things." But directionally, if GDP is growing—especially if GDP per capita is growing—surely that is a good thing. And in general, you're probably right; it probably is a good thing. But there's also things that GDP is not capturing. It is not capturing, even if you were able to measure non-marketed goods and services or under-the-table or illegal activity, it doesn't capture things like, let’s say, pollution. You could have a country whose GDP is growing very, very fast, but in the process, the country gets very, very polluted. Maybe that makes the quality of life go down in certain areas.

Health is another issue. In general, countries with a high GDP per capita usually do have good health care, mainly because of their—they have more resources for health care. But you want to look at that, how is the health trending in a country? And then you could even think about stuff like stress or a feeling of community or support. These are all things that would affect any human being's well-being, but they are not, of course, captured in GDP.

Now to appreciate the different ways of ranking countries in an attempt to get at well-being, you could first of all look at GDP rankings. So here are rankings by the World Bank for 2016. You see the United States is on top with 18.6, almost trillion dollars of GDP as measured by the World Bank, and you see the ranking. Now, if you wanted to go by per capita because you say, “Hey, this doesn’t tell you how many people are there. What matters is how much good—how much productivity divided by the number of people?” If you want to really measure per person well-being, well then you might look at something like this GDP per capita. And notice here the United States is still quite high, but it's nowhere near as high as Luxembourg. The reason why Luxembourg didn't show up on the other list is it is a very, very small country—its population is very small compared to the United States. Same thing for Switzerland or for Macau.

Now another thing to appreciate is this GDP per capita just takes the nominal GDP and divides it by the number of people there are in a country, but it does not measure or indicate things like wealth inequality. It's not that every person in Luxembourg gets exactly a hundred and three thousand dollars worth of goods and services. Depending on the country, there might be more of a middle class or less of a middle class; there might be more wealth inequality or less wealth inequality, and once again that is not captured by GDP. Also, even the GDP per capita doesn't really tell you how much you can buy with that per capita GDP. And so that's why people look at things like purchasing power parity. This is a sense of per capita GDP but adjusted for how much you could buy with those resources that are measured in U.S. dollars.

So now all of a sudden, Qatar at the top—Qatar was pretty high—but I guess you can buy more and get more goods and services with that nominal GDP per capita measured in U.S. dollars in Qatar than you could say in the United States. So I will leave you there. There's no such thing as an absolutely perfect measure of economic activity, much less well-being, but GDP is the best measure that we have, although I encourage you to think of others. For example, the UN has tried to measure happiness. They have this ranking of happiness; they have an annual World Happiness Report, and I'm not going to go into all of the details, but beyond GDP, it also considers things like health or other measures of well-being. And as you can see, the countries at the top here tend to have fairly high GDPs, but this ranking is not the same as the ranking that we saw on the GDP per capita with the purchasing power parity. And so these are all very interesting things to think about.