💰 Real vs Nominal GDP
Core distinction: Nominal GDP can rise just because prices go up, even if actual production hasn't changed. Real GDP strips out inflation so we can see true growth.
Why this matters
If nominal GDP rises 5% but prices also rose 5%, real output hasn't grown at all. Economists always use real GDP to measure genuine economic growth.
Real GDP = Nominal GDP ÷ GDP deflator × 100. The GDP deflator is a price index that measures the average price level relative to a base year. You don't need to calculate it, but you must understand the concept.
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🌍 GDP Per Capita and PPP
GDP per capita
GDP per capita. China has a higher total GDP than Switzerland, but Switzerland's GDP per capita is much higher.
Purchasing power parity (PPP)
Purchasing power parity (PPP).
- Without PPP, we convert all GDP to USD at market exchange rates — but $1 buys very different amounts in different countries.
- PPP adjusts for this, giving a more accurate picture of what people can actually afford.
- Always use GDP per capita at PPP for living-standard comparisons.
Example: India's GDP per capita is about $2,500 at market exchange rates but around $9,000 at PPP — because goods and services are much cheaper in India.
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⚠️ Limitations of GDP as a Measure of Well-Being
GDP measures the total value of output, but it does NOT tell us everything about quality of life:
- Income distribution — GDP per capita is an average; it hides inequality. A country can have high GDP per capita but extreme poverty for many.
- Non-market activity — household work, childcare, and volunteer work aren't counted in GDP but improve well-being.
- Informal/shadow economy — undeclared economic activity (common in developing countries) is missed.
- Negative externalities — GDP counts pollution-creating output as positive. Cleaning up pollution also adds to GDP!
- Quality of life — GDP doesn't measure leisure time, health, education quality, safety, or freedom.
- Sustainability — GDP can rise by depleting natural resources, which harms future well-being.
The IB often asks: "To what extent is GDP a good measure of well-being?" Know 3–4 limitations and be able to suggest alternative indicators like the HDI (Human Development Index) or GPI (Genuine Progress Indicator).