Limitations of GDP as a measure of welfare Class 12

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In this lecture, we will discuss whether GDP (Real GDP) or per capital real GDP is the real measure of Welfare or not. If Not what are the limitations of real GDP as the measure of welfare

Before we go through this topic first let’s understand what does welfare mean in economics.

What do you mean by Welfare in Economics Class 12?

In Economics welfare refers to the sense of well being among the people. This sense of well being influenced by many factors.

Such as, consumption level, types of goods and services consumed, environmental pollution and law and order situation etc.

If consumption level increases, quality of goods and services increases, a great law and order situation increases the welfare. On the other hand, increase in pollution level decreases the welfare and vice versa.

welfare is affected by both economic and non-economic factors.

Economics factors includes, National income, consumptions

Non-Economic factors includes, Environmental pollution, law and order situation etc.

Economics Welfare

When, sense of well being are affected by economic factors. It is called Economic Welfare.

Non-Economic Welfare

When, sense of well being are affected by non-economic factors. It is called Economic Welfare.

What is Social Welfare.

The sum total of Economic and Non-Economic Welfare is called Social Welfare.

In class 12 CBSE Board, However we will examine only the direct effects of increase in GDP on economic welfare.

Limitations of GDP as the measure of Economic Welfare.

GDP is the best indicator of economic welfare. But there are many reasons it is not an adequate measure of it. There are many reasons to support this argument.

Non-Monetary Exchanges:-

There are many activities that are left out from the estimation of National Income. These activities are non-monetary and non market transactions. For example,

  1. Services of Housewife
  2. Kitchen gardening
  3. services of family members to each other
  4. own account production
  5. leisure time activities etc.

These non-exchange and non-monetary production activities are left out from GDP on account of the non-availability of data and the problem of evaluation.

However, such activites contribute to the economic welfare.

So, if we depend only on GDP, we are underestimating the economic welfare.


When the activities of one result in benefits or harm to others with no payment received for benefits and no penalty of harm. Such benefits and harm are called externalities.

Activities resulting in benefits are called positive externalities and increase in welfare and activities resulting in harm are called negative externalities and resulting in decrease in welfare.

GDP does not take into account such externalities. Thus if we depend only on GDP, we are underestimating the economic welfare.

For example, construction of a flyover results in flow of goods and services and counted in GDP. But the flyover, reduces the transport cost and journey time to those who have not contributed into its construction.

construction of flyover is counted in GDP. But not the positive externalities such as reducing transport cost and journey flowing out of it.

On the other hand, a plastic factory provides employment in the locality. It is counted in GDP, but the negative externalities such as pollution spread by it making people sick are not counted.

Distribution of GDP:-

The GDP does not take into account the unequal distribution of income in a country. It may possible with rise of GDP, inequalities in the distribution of GDP may also rise.

It means the income of rich people rises by many folds than the common man. Overall GDP would seem to rise, but richer are getting richer, poorer are getting poorer.

So, if we only depend GDP as the measure of economic welfare. We are underestimating it.

All Products may not contribute equally in Economic welfare

GDP includes the production of all types of goods and services produced such as food, clothes, houses, military equipments, police services, etc.

In the above mentioned, goods and services, food, clothes, houses directly contribute more to the economic welfare. But police and military services contribute less to welfare.

Therefore, How much is the economic welfare depends on the types of goods and services produced not how much is produced.

So, if we only depend GDP as the measure of economic welfare. We are underestimating it.

Contribution of Some products may be negative:-

The GDP includes the monetary of value of all types of goods and services produced in the economy. For example production of vital food such as wheat rice provides immediate satisfaction to the consumers.

On the other hand, tobacco, liquor may provide instant satisfaction but its afterward harmful effects leads to health hazard.

Such products however, increases GDP in monetary terms but reduces economic welfare.

Hence, if we only depend upon the GDP for Economic welfare. We are under-estimating it.

Change in Prices:-

If increase in GDP is due to rise in prices and not due to increase in physical output. It will not be a reliable index of economic welfare.

Rate or Population Growth:-

GDP does not consider the changes in population of a country. If rate of population growth is higher than the rate of GDP.

It would decrease the per capital availability of goods and services, which will adversely affect the economic welfare.

Thus if we only depend on the GDP for the economic welfare. We are under or overestimating it.

Further Reading:-

1.What is Macroeconomics
2.What are Goods in economics
3.What are Consumption Goods
4.What are capital goods
5.What are intermediate Goods
6.What is intermediate consumption
7.What are final Goods
8.What is Final Consumption
9.What is investment in economics
10. What is stock and flow
11.What are transfer payments
12.What is circular flow of income
13.What is Domestic Territory of a Country
14.What is normal resident of a country
15.Nominal GDP and Real GDP
1.What is GDP Deflator
2.What are externalities in economics
3.Limitations of GDP as a measure of welfare
1.Items to be included in National income
2.Items to be included in Domestic Income
1.National Income and Related Aggregates, formula, Definition, process
2.Value added Method, formula, Definition, process
3.Income Method, formula, Definition, process
4.Expenditure Method, formula, Definition, process
1.150+ Numerical of Value Added Method
2.150+ Numerical of Income Method
3.150+ Numerical of Expenditure Method
4. 150+ Numerical of National Income and related aggregates
1.250+ MCQs of National Income
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Anurag Pathak

Anurag Pathak is an academic teacher. He has been teaching Accountancy and Economics for CBSE students for the last 18 years. In his guidance, thousands of students have secured good marks in their board exams and legacy is still going on. You can subscribe his youtube channel and can download the Android & ios app for free lectures.

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