Real Gross Domestic Product, GDP Per Capita, And Limitations Of GDP As A Measure Of Welfare

(1) Real GDP and real GDP per capita for Sydney are different. Define the two terms in italics and explain carefully why they differ.

(2)Martin notes two very significantly different growth rates in regional NSW and regional Victoria. Compare the effect of these two different growth rates on GDP if they were sustained over a period of 20 years.

(3)GDP per capita is considered a “rough measure of living standards”. Outline at least two limitations of GDP as a measure of economic welfare and then suggest two other economic indicators that could be useful in terms of measuring well-being, explaining your choices.

(4) According to the article and in consideration to Sydney’s economy, “the Reserve Bank would have to push up cash rate”. Explain the effects of this decision on the economy of Sydney.
 

Real Gross Domestic Product and GDP per capita

Real Gross Domestic Product is a measure of aggregate output in an economy that is adjusted for inflation or deflation (Agénor and Montiel 2015). Gross Domestic Product represents the market value goods and services produced within the economy. GDP is computed using either current market price or market price of a fixed base year. GDP obtained using market price of fixed base year is called real GDP.

Real GDP per capita is the measure for average income of a nation. It is obtained by dividing real GDP by population of the country (Bernanke, Antonovics and Frank 2015). Unlike real GDP, it represents output per person and thus indicates living standard.

In 2015-16, the GDP of Sydney was $400.9 billion. When divided by total population per capita real GDP is obtained as $81,000 (sgsep.com.au 2017).  Real GDP in Sydney has increased significantly in recent years. The largest contributor to real GDP are professional services, wholesale trade and financial and insurance service. The real estate, health care, manufacturing and telecommunication contributed nearly 0.2 to 0.3 percentage point in GDP growth. Population growth plays an important role in driving economic growth. In order to eliminate this impact per capita GDP is computed. Since 2004-05, per capita GDP of Sydney remain higher than national average. A higher real GDP does not imply a higher per capita GDP. This in turn depends on the extend of population growth. The population in Sydney has grown at a faster rate in the last few years (smh.com.au 2018). The real GDP growth however offset the population growth causing per capita GDP in Sydney to grow continuously.

2. The growth rate in New South Wales and Victoria can be computed using the cumulative growth rate formula 

(Source: abs.gov.au 2018) 

Table 1: Growth in New South Wales

As suggested from growth statistics, it is observed that during 2013-14, the regional New South Wales has recorded a contraction in growth rate. The growth rate fell to 1.96%.  In the next year this during 2014-15, slow growth has slightly improved and the economy accounted a growth of 2.80 percent. The slow growth in New South Wales has resulted from a decline in manufacturing sector. In the last two years, the economic growth has recovered and the region recorded a growth relatively strong growth rate of 3.85 percent and 2.87 percent.

(Source: abs.gov.au 2018) 

Table 2: Growth in Victoria

The growth rate in regional Victoria recorded a weak performance in three of the last ten years. However, in most recent years the economy is growing at a growth rate of 3.33 percent. The growth rate is higher than the current growth rate of New South Wales. The factors contributing to a strong growth in Victoria are strong agricultural production and associated strong growth in manufacturing.

Growth rates of New South Wales and Victoria

The higher growth of Victoria enhances economic performance of all other sectors.  The better growth performance results in economic expansion which in turn stimulates future economic growth. The higher growth prospects of these regions contribute to a higher growth for the nation as a whole. 

3. Gross Domestic Product represents the monetary value of produced goods and services of a nation in a particular accounting year. GDP thus is a representative of aggregate activity in a nation. GDP often used to measure the level of social welfare. The idea is to correlate different form of expenditure with social welfare through GDP (Mankiw 2014). However, the welfare argument in line with GDP is very simplistic. Use of GDP as an indicator of welfare have several limitations. GDP excludes many factors that are important for social welfare.

GDP does not include any measure of welfare. It only describes the market value of finished goods and services within a nation for a given period of time. GDP can be computed using different computational method like total product approach, income approach and expenditure approach but none of the measures include any indicator for welfare (Jones and Klenow 2016). Social welfare depends on several qualitative aspects like education, happiness and others, GDP being only a quantitative measure include none of the qualitative aspect of social welfare.

Another limitation of GDP is that it accounts for transaction take place in the market. It does not incorporate voluntary or domestic work even though they have significant positive influence on social welfare. These activities actually complement market activities and hence have a significant contribution on standard of living (Fleurbaey and Blanchet 2013). Additionally, there are various activities that take place outside the domain of formal market. Exchange take place in black markets or illegal transaction like corruption have an adverse effect on social welfare though not included in GDP.

GDP also does not account for degree of income inequality in the nation. In nations with high income inequality, GDP might however be high but most people unable to afford basic necessities. Therefore, GDP alone cannot reflect economic welfare.

In context of several shortcoming of GDP, it fails to portrait the actual picture of welfare. Alternative measures thus need to be developed for capturing social welfare. The alternative measure should focus on both qualitative and quantitative aspect of welfare. One alternative measure can be Human Development Index (HDI). HDI is complete measure of economic development. In addition to income, HDI includes several other dimension of economic welfare.  It measures achievement in three crucial dimensions – health and life expectancy, level of education and standard of living (Mankiw 2014). The inclusion of two supplementary dimensions make HDI a more accurate index of social and economic welfare.

Limitations of GDP as a measure of welfare

Social Progress Index is another alternate to GDP as a measure of welfare. The index is based on three primary dimensions- basic needs of human, the foundation of well-being and opportunity. Each of these aspect again depends on several factors. Before measuring social progress index each of its components are first computed by multidimensional index. Various factors under human needs include level of nutrition, availability of medical care and safety measures (Fleurbaey and Blanchet 2013). Education, sustainability and wellness are the foundations for well-being. The third indicator, opportunity include personal right to human, tolerance and freedom.

4. The economy of Sydney has accounted nearly half of the national growth rate. The growth rate exceeds growth rates in most other region of Australia. The increasing growth rate of Sydney has resulted in an increased living cost of Sydney. The low cash is a tool of monetary easing policy. This by lowering cost of credit helps to boost economic growth (abc.net.au 2018). Low cost of mortgage flowing low cash rate has considerably raised property price in Sydney. With almost same size and economic environment Melbourne is much cheaper than Sydney. In order to control prices and counter possible housing market bubble the Reserve Bank of Australia should take a tight monetary policy in terms of raising the cash rate from 1.5 percent to 3.5 percent (smh.com.au 2018). The cash rate influences borrowing and lending activities, economic activity and finally on inflation rate on the economy. The higher cash means borrowers now have to pay a higher amount of return. This would make borrowing less attractive to the people in Sydney. Borrowing is a major source to finance housing demand. With a decline in borrowing, the housing demand will be reduced. This by reducing demand of housing releasing upward pressure on housing price. With an increase in cash rate, return on savings increases. More and more people in Sydney will now be interested to keep their money in banks. This in turn reduces consumption demand in Sydney. The increased cash rate thus by reducing housing price and commodity price helps to control overall inflation. 

References

ABC News. (2018). Tell him he's dreaming: Why the RBA can't raise interest rates. [online] Available at: https://www.abc.net.au/news/2017-07-17/interest-rates-four-reasons-why-rba-cannot-raise-them/8714010 [Accessed 14 Apr. 2018].

Abs.gov.au. (2018). 5220.0 - Australian National Accounts: State Accounts, 2016-17. [online] Available at: https://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPage/5220.02016-17?OpenDocument [Accessed 14 Apr. 2018].

Agénor, P.R. and Montiel, P.J., 2015. Development macroeconomics. Princeton University Press.

Bernanke, B., Antonovics, K. and Frank, R., 2015. Principles of macroeconomics. McGraw-Hill Higher Education.

Fleurbaey, M. and Blanchet, D., 2013. Beyond GDP: Measuring welfare and assessing sustainability. Oxford University Press.

Jones, C.I. and Klenow, P.J., 2016. Beyond GDP? Welfare across countries and time. American Economic Review, 106(9), pp.2426-57.

Mankiw, N.G., 2014. Principles of macroeconomics. Cengage Learning.

Martin, P. (2018). Sydney powers the nation, accounting for almost half of Australia's economic growth. [online] The Sydney Morning Herald. Available at: https://www.smh.com.au/business/the-economy/sydney-powers-the-nation-accounting-for-almost-half-of-australias-economic-growth-20171204-gzyj04.html [Accessed 14 Apr. 2018].

Sgsep.com.au. (2017). Sydney GDP 2015-2016 - SGS Economics & Planning. [online] Available at: https://www.sgsep.com.au/publications/sydney-gdp-2015-2016 [Accessed 14 Apr. 2018].

Wade, M. (2018). Sydney's population tops five million, ABS data shows. [online] The Sydney Morning Herald. Available at: https://www.smh.com.au/national/nsw/sydneys-population-tops-five-million-abs-data-shows-20170330-gv9pnq.html [Accessed 14 Apr. 2018].