The following article will guide you about whether GDP is a good measure of economic well-being or not.

Consider the economy that produces only apples and oranges. In this simple economy GDP is the sum of the value of all the apples and the value of all the oranges produced. That is,

GDP = (Price of apples x Quantity of apples) + (Price of oranges x Quantity of oranges).

GDP can increase cither because prices rise or quantities rise.

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GDP computed in this way is not a good measure of economic well- being. That is, it does not accurately reflect how well the economy can satisfy the demands of households, firms and the government. If all prices double without any change in quantities, GDP would double.

Yet it would be misleading to say that the economy’s ability to satisfy demands has doubled, because the quantity of every good produced remains unchanged. We call the value of goods and services measured at current prices nominal GDP.

A better measure of economic well-being would be the economy’s output of goods and services that would not be influenced by changes in prices. For this purpose, economists use real GDP which is the value of goods and services measured at constant prices. To compute real GDP, a base year is chosen —say. 1992. Goods and services arc then added up using 1992 prices to value the different goods. In our two-goods economy, real GDP for 1996 would be

Real GDP = (1992 prices of apples x 1996 Quantity of apples) + (1992 prices of oranges x 1996 Quantity of oranges).

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Similarly, real GDP in 1997 would be

Real GDP = (1992 prices of apples x 1997 Quantity of apples) + (1992 prices of oranges x 1997 Quantity of oranges).

Because the prices are held constant, real GDP varies from year to year only if the quantities vary. Thus, real GDP summarises the output of the economy measured in base-year (1992). Because the ability of the society to provide satisfaction for its members depends on the quantities of goods and services produced, real GDP provides a better measure of economic well-being than nominal GDP.