NOMINAL AND REAL GDP and it's limitations

Economy and Finance

NOMINAL AND REAL GDP and it's limitations

27 Aug 2023 Zinkpot 144

Gross Domestic Product at current prices is the monetary value of all final goods and services produced by all the enterprises located within the domestic territory of the country during a particular year based on the price of goods and services of the same year.
Nominal GDP is the GDP of a country at the current price. In other words, for GDP at current prices the output and market prices are used of the same year.
For example, if we measure the GDP of India for the year 2012-13 at 2012-13 prices, it is GDP at current prices. Nominal GDP is the GDP without any effect of inflation.
Real GDP is the GDP of a country at a constant price. Real GDP is the monetary value of all goods and services produced within the domestic boundaries of a country based on the price of goods and services of the base year.
Goods and services included in the GDP of each year are valued at the prices of the base year in calculating Real GDP.
For instance, if we take prices of 2011-12 as the base year prices and express GDP of 2012-13 at 2011-12 prices, the GDP so is estimated as GDP at constant prices. Real GDP is the inflation-adjusted GDP of a country.
Nominal GDP can change from one year to another, partly because of a change in physical quantities of final goods and services and partly because of the change of market prices at which these goods and services are valued. Therefore, nominal GDP does not reflect growth in real domestic output.
But, real GDP is affected by changes in physical quantities of final goods and services only. Consequently, an increase in real GDP indicates a real increase in the physical quantities of goods and services Thus, the real GDP reflects the real growth of an economy Therefore, it is a better and more reliable index of growth of an economy.
LIMITATIONS OF GDP
GDP is a useful indicator of a nation’s economic performance and it is the most commonly used measure of well-being. However, it has some important limitations:
Exclusion of non-market transactions: These activities refer to those goods and services which are not exchanged in the market at market prices. The service of housewives or families growing vegetables in the kitchen garden of the house are examples of such transactions.
Failure to account for the degree of income inequality in society: GDP is only a partial index of economic welfare because economic welfare depends not only on the size of income but also on the distribution of income that accompanies an increase in national income. An increase in inequalities of income may reduce the economic welfare of the people, in general.
Quality of life: Economic welfare depends on the quality of life. But GDP does not include many indicators of quality of life. Quality of life depends on, in addition to GDP, social indicators like life expectancy, child mortality rate, adult literacy, years of schooling, quality of city life, etc. which are excluded from GDP.
Expenditure on regrettable necessities: There are certain expenditures that are forced on consumers. Such expenditures are called expenditures on regrettable necessities. Expenditures on transport to reach the place of work, expenditures on medical treatment because of pollution in the cities, etc., are examples of such expenditures. All such expenditures are included in GDP, but they do not increase economic welfare.
Manner of increase in GDP: If the increase in GDP is the result of longer working hours, increased employment of the child labor force, the unhealthy and polluted atmosphere in the factories, ruthless exploitation of natural resources, etc. such an increase in GDP will not increase the welfare of people. In fact, an increase in environmental pollution may lead to fall in economic welfare.