GDP Limitations of GDP 2 — Questions and Answers
Question 1: Why does GDP fail to capture income inequality within a country?
- It only measures government spending
- It reports a single aggregate figure that masks how income is distributed among individuals (Correct answer)
- It excludes foreign income earned by residents
- It double-counts corporate profits
Correct answer: It reports a single aggregate figure that masks how income is distributed among individuals
GDP is an aggregate measure, so a high GDP can coexist with extreme poverty if wealth is concentrated among few people.
Question 2: Which of the following household activities is EXCLUDED from GDP calculations?
- Hiring a professional chef to cook meals
- Paying a nanny to care for children
- A parent cooking meals for their own family (Correct answer)
- Purchasing groceries from a supermarket
Correct answer: A parent cooking meals for their own family
GDP only counts market transactions, so unpaid household labor like cooking for one's own family is excluded.
Question 3: How does GDP treat environmental degradation caused by industrial production?
- It subtracts the cost of pollution from output
- It ignores it and counts only the market value of goods produced (Correct answer)
- It adds a penalty tax to the GDP figure
- It separates environmental costs into a satellite account
Correct answer: It ignores it and counts only the market value of goods produced
Standard GDP does not deduct environmental damage, so pollution-heavy growth can appear as economic progress.
Question 4: A country rebuilds infrastructure after a major hurricane. How does this affect GDP?
- GDP falls because wealth was destroyed
- GDP is unaffected because repairs cancel out losses
- GDP rises because reconstruction spending counts as economic activity (Correct answer)
- GDP falls because government debt increases
Correct answer: GDP rises because reconstruction spending counts as economic activity
Reconstruction spending adds to GDP even though it merely restores what was lost, illustrating GDP's inability to distinguish beneficial from defensive spending.
Question 5: What does the term 'underground economy' refer to in the context of GDP limitations?
- Agricultural output produced in rural areas
- Legal but unreported cash transactions and illegal economic activity not captured in GDP (Correct answer)
- Transactions conducted on the stock market
- Government contracts awarded without public bidding
Correct answer: Legal but unreported cash transactions and illegal economic activity not captured in GDP
The underground economy includes unreported legal work and illegal activity, both of which are excluded from official GDP figures.
Question 6: Why might a rise in GDP not reflect a true improvement in living standards?
- GDP always overstates inflation
- Increases in GDP could stem from longer working hours rather than greater productivity or leisure (Correct answer)
- GDP grows faster than population in developed countries
- Rising GDP always reduces unemployment
Correct answer: Increases in GDP could stem from longer working hours rather than greater productivity or leisure
If GDP grows because people work more hours rather than becoming more productive, individuals may actually enjoy less leisure and lower quality of life.
Question 7: Which metric was developed specifically to address GDP's failure to measure overall well-being?
- Consumer Price Index (CPI)
- Human Development Index (HDI) (Correct answer)
- Producer Price Index (PPI)
- Federal Funds Rate
Correct answer: Human Development Index (HDI)
The HDI incorporates life expectancy, education, and per-capita income to provide a broader measure of human well-being beyond GDP alone.
GDP Limitations of GDP 2
Why does GDP fail to capture income inequality within a country?