Limitation of National Income

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INTRODUCTION
Defining and measuring the standard of living
The standard of living is a measure of the material welfare of the inhabitants of a country. The baseline measure of the standard of living is real national output per head of population or real GDP per capita. This is the value of national output divided by the resident population. Other things being equal, a sustained increase in real GDP increases a nation’s standard of living providing that output rises faster than the total population.  However it must be remembered that real income per capita on its own is both an inaccurate and insufficient indicator of true living standards both within and between countries. National income data can be used to make cross-country comparisons. This requires * Converting GDP data into a common currency (normally the dollar or the Euro) * Making an adjustment to reflect differences in the average cost of goods and services in each country to produce data expressed at a ‘purchasing power parity’ standardLimitations of national income and standard of living.Problems in using national income statistics to measure living standards GDP data on its own is an insufficient indicator of our economic well-being. The following quote adapted from an article in the Independent in December 2002 sums up the issue quite well. ‘Improving living standards is about poor families gaining access to what is available at the time to make life comfortable, healthy and rewarding. In the end, economic statistics only measure what they measure, which may not bear much relation to how well off we are.’ Source: Adapted from the Independent  The table below provides time series data on per capita national incomes for the twenty five nations of the European Union. Ireland has made huge strides in improving her relative standard of living. In 1994 Ireland’s GDP per capita was just 84% of the EU average but extremely rapid economic growth allowed the Irish economy to surge past the EU15 average in 1999 and this progress has been maintained. In contrast, Germany’s relatively slow growth has seen erosion in her relative advantage in living standards – from a level 10% above the EU average in 1994 to a level only 3% above the average in 2002. In 2004, Britain had a per capita income (adjusted for differences in living costs) some ten per cent higher than the European average.Average GDP per head of the ten accession countries in the year 2000 was only 46% of the EU average although it should be pointed out that there has been progress in closing this gap over recent years. Many transition economies experienced a deep recession in the early 1990s but have grown more quickly since then. Of the ten accession countries, Cyprus and Slovenia are closest to the EU average in terms of a PPP adjusted income per capita. GDP and living standards - problems of accuracyOfficial data on a nation’s GDP tends to understate the true growth of real national income per capita over time due to the expansion of the shadow (or underground) economy and also the value of unpaid work done by millions of volunteers and people caring for their family members.Various definitions are used to describe the "shadow economy" but the definition usually embraces a range of illegal activities such as drug production and distribution, prostitution, theft, fraud and concealed legal activities such as tax evasion on otherwise-legitimate business activities such as unreported self-employment income. The scale of the “shadow economy” varies widely across countries at different stages of development. According to the IMF, in developing countries it may be as high as 40% of GDP; in transition countries of central and Eastern Europe it may be up to 30% of GDP and in the leading industrialised countries of the OECD, the shadow economy may be in the region of 15% of GDP. GDP and living standards – problems of interpretationHere are reasons why GDP data may give a distorted picture of living...
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