GDP Limitations of GDP 3 — Questions and Answers
Question 1: How does GDP handle the depreciation of capital goods over time?
- GDP adds depreciation as a positive contribution
- Gross GDP does not subtract depreciation; Net Domestic Product (NDP) does (Correct answer)
- GDP automatically adjusts for depreciation using inflation data
- Depreciation is excluded only from nominal GDP
Correct answer: Gross GDP does not subtract depreciation; Net Domestic Product (NDP) does
Gross GDP counts total output without deducting capital wear-and-tear; NDP corrects this by subtracting depreciation.
Question 2: Why is GDP per capita considered an imperfect measure of the average citizen's welfare?
- It is calculated in foreign currencies
- It divides total output equally across the population, ignoring unequal distribution (Correct answer)
- It excludes service sector output
- It only counts formal sector employment
Correct answer: It divides total output equally across the population, ignoring unequal distribution
GDP per capita assumes income is evenly distributed, but in reality wealth concentration means many people earn far less than the average suggests.
Question 3: A surge in healthcare spending due to a widespread disease causes GDP to rise. This illustrates which GDP limitation?
- GDP cannot measure international trade flows
- GDP counts defensive and remedial spending the same as productive spending (Correct answer)
- GDP ignores government expenditure
- GDP excludes service industries
Correct answer: GDP counts defensive and remedial spending the same as productive spending
GDP treats money spent fighting illness as positively as money spent on innovation, failing to distinguish between desirable and undesirable economic activity.
Question 4: Which of the following is a limitation of using nominal GDP to compare economies across different years?
- Nominal GDP does not include government spending
- Nominal GDP is distorted by price-level changes, making real output comparisons unreliable (Correct answer)
- Nominal GDP excludes imports and exports
- Nominal GDP cannot be calculated for service-based economies
Correct answer: Nominal GDP is distorted by price-level changes, making real output comparisons unreliable
Nominal GDP rises with inflation even if actual output stays flat, so real GDP (adjusted for prices) is needed for accurate comparisons over time.
Question 5: How does the digital economy challenge the accuracy of GDP measurement?
- Digital goods are taxed at higher rates, inflating GDP
- Many digital services are free to users and thus have zero market price, so their value is understated in GDP (Correct answer)
- Digital firms are excluded from national income accounts
- Internet commerce is only counted in trade statistics, not GDP
Correct answer: Many digital services are free to users and thus have zero market price, so their value is understated in GDP
Free digital services like social media and search engines provide enormous consumer value but record no market revenue, causing GDP to understate their contribution.
Question 6: Why is GDP considered a poor indicator of sustainability?
- GDP is calculated annually rather than quarterly
- GDP does not account for depletion of natural resources or long-term environmental costs (Correct answer)
- GDP counts only manufactured goods, not natural resources
- GDP grows slower in resource-rich countries
Correct answer: GDP does not account for depletion of natural resources or long-term environmental costs
A country can boost GDP by rapidly depleting forests or minerals while creating future scarcity, since GDP does not subtract natural capital losses.
Question 7: A country's GDP grows by 4% but its population grows by 5%. What does this imply about living standards?
- Living standards are improving because GDP is growing
- Living standards are likely falling because output per person declined (Correct answer)
- Living standards are unchanged because GDP still grew positively
- Living standards depend only on nominal GDP, not population
Correct answer: Living standards are likely falling because output per person declined
When population growth outpaces GDP growth, GDP per capita falls, meaning the average person has access to fewer goods and services.
GDP Limitations of GDP 3
How does GDP handle the depreciation of capital goods over time?