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8. Economic Indicators (GDP and Standard of Living)

The government can only make effective decisions about fiscal policy and other actions if it has good information on how the economy is doing. The most fundamental measure of the economy is its size. And one way to measure the size of an economy is to calculate the market value of all the goods and services it produces (from cars to haircuts) in a given period, such as a year. This is called the Gross Domestic Product, or GDP for short. The GDP provides a snapshot of a country’s economy and is the most common (and famous) macroeconomic indicator. Economists use the GDP to make presumptions about the countries´ future economic growth while policy makers such as central bankers base their monetary policy on this indicator. GDP is the most common measure of an economy’s size and prosperity, but it is not perfect: For example, some goods and services do not have a market price (e.g., schools, street lightning provided by the government) and the GDP does not account for environmental damage that the production of goods and services may cause.

The more goods and services a country can produce, the larger is its economy, as measured by GDP. But does high GDP necessarily mean a mean high standard of living for the average person?

The standard of living refers to the amount of wealth available to a society and encompasses such factors as income or life expectancy. One common (yet narrow) way to estimate living standards is to divide the value of all goods and services produced in a country during a year by the country’s population. This is called GDP per capita, or per head. It tells us the income that the economy generates for each of its people. The higher this figure, the more goods and services the economy provides to the average person, thus raising their living standards (making them richer).

GDP per capita is useful for looking at how rich a country is in comparison with others. Differences among countries are certainly vast. For example, GDP per capita in India is around eight times less than in the United States. In other words, the average person in India is much poorer than the average American. Just as importantly, GDP per capita changes over time. Over the last 20 years, GDP per capita in India has almost tripled. In other words, the average person in India got almost three times richer during that time – a substantial improvement in living standards.

High GDP per capita certainly does not mean that each person receives a high income. The value of economic output is not distributed evenly among the population, as some earn much more than others, even after accounting for redistributive government policies like taxes and benefits.

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