2.2 — Limitations of GDP

Not Included in GDP

1. Intermediate Goods: Avoids double counting.
   • Example: Price of a car, not its parts.
2. Non-Production Transactions:
   • Financial Transactions: Stocks, bonds, real estate.
   • Used Goods: Old cars, thrifted clothes.
3. Non-Market/Illegal Activities:
   • Example: Illegal drugs, unpaid work.

Problems with GDP

• Inflation: Rising prices can make GDP look larger even without increased production.
  • Example: Year 1: 10 apples at $1 = $10; Year 2: 10 apples at $1.25 = $12.50.
• Population Differences: Larger GDP doesn’t mean a higher standard of living unless adjusted for population size.

Real vs. Nominal GDP

• Nominal GDP: Measured in current prices, unadjusted for inflation.
• Real GDP: Adjusted for inflation, expressed in constant dollars.

This is further described in 2.6 — Real vs. Nominal GDP.

Real GDP Per Capita

Real GDP per capita measures the average production per person:

$$\text{Real GDP per Capita}=\frac{\text{Real GDP}}{\text{Population}}$$

It is the best indicator of a nation’s standard of living.