GDP is a widely used measure of a
country's production and wealth. But, like other figures, it is not the perfect
measure of the country's economy in all aspects. Specifically, it has
limitations due to the following:
1. Differences in the distribution of income
Although some countries may have similar GDP per capita, the
distribution of income in each country may be very different as GDP per capita
only shows the average value.
2. International price differences
International prices will also vary, which is significant because purchasing power is based on
price in relation to income. To solve this problem, GDP statistics can be
recalculated in terms of purchasing power. The purchasing power of a currency
refers to the quantity of the currency needed to purchase a given unit of a good
or common basket of goods and services. Purchasing power is determined by the
relative cost of living and inflation rates in different countries. Purchasing
power parity
means equalizing the purchasing power of two currencies by taking
into account cost of living differences. For example, if we simply convert GDP
in Malaysia to US dollars using market exchange rates, relative purchasing power
is not taken into account and GDP would not show Malaysia’s economic performance
well. By adjusting rates to take into account local purchasing power
differences, known as PPP adjusted exchange rates,
international comparisons are more valid.
3. Currency conversion
GDP figures for
different countries must be converted to a common currency, such as the US
dollar, and this may give misleading figures. Exchange rates against the US
dollar may not be accurate for countries whose international trade is relatively
small. In such cases converting to US dollars may significantly under-value
national output.
4. Difficulty of assessing true values
The true value of public goods such as
defense and transport infrastructure and, and merit goods, such as healthcare
and education, has not been calculated precisely. This means it is difficult to
compare two countries with different spending on these goods and assets.
5. Differences in hours worked
As when comparing a country over time, the
number of hours worked to generate a given level of income may be quite
different.
6. Hidden economies
Existence of a hidden economy hinders GDP from showing reality. To avoid tax, transactions
may go unrecorded and excluded from official
statistics.
country's production and wealth. But, like other figures, it is not the perfect
measure of the country's economy in all aspects. Specifically, it has
limitations due to the following:
1. Differences in the distribution of income
Although some countries may have similar GDP per capita, the
distribution of income in each country may be very different as GDP per capita
only shows the average value.
2. International price differences
International prices will also vary, which is significant because purchasing power is based on
price in relation to income. To solve this problem, GDP statistics can be
recalculated in terms of purchasing power. The purchasing power of a currency
refers to the quantity of the currency needed to purchase a given unit of a good
or common basket of goods and services. Purchasing power is determined by the
relative cost of living and inflation rates in different countries. Purchasing
power parity
means equalizing the purchasing power of two currencies by taking
into account cost of living differences. For example, if we simply convert GDP
in Malaysia to US dollars using market exchange rates, relative purchasing power
is not taken into account and GDP would not show Malaysia’s economic performance
well. By adjusting rates to take into account local purchasing power
differences, known as PPP adjusted exchange rates,
international comparisons are more valid.
3. Currency conversion
GDP figures for
different countries must be converted to a common currency, such as the US
dollar, and this may give misleading figures. Exchange rates against the US
dollar may not be accurate for countries whose international trade is relatively
small. In such cases converting to US dollars may significantly under-value
national output.
4. Difficulty of assessing true values
The true value of public goods such as
defense and transport infrastructure and, and merit goods, such as healthcare
and education, has not been calculated precisely. This means it is difficult to
compare two countries with different spending on these goods and assets.
5. Differences in hours worked
As when comparing a country over time, the
number of hours worked to generate a given level of income may be quite
different.
6. Hidden economies
Existence of a hidden economy hinders GDP from showing reality. To avoid tax, transactions
may go unrecorded and excluded from official
statistics.