Gross domestic product (GDP) measures the total output of an entire economy by adding up total consumption, investment, government expenditure, and net exports. GDP is therefore considered a quality approximation of income for an entire economy in a given period.

Per capita GDP is calculated by dividing total GDP by a country's population, and this figure is frequently cited when assessing the standard of living. There are a number of adjustments to GDP used by economists to improve the explanatory power of the statistic, and economists have also developed a number of alternative metrics to measure the standard of living.

Key Takeaways

  • Gross domestic product, or GDP, measures the total output of the economy, including activity, stability, and growth of goods and services; as such, it's seen as a proxy for the economy.
  • The standard of living is derived from per capita GDP, determined by dividing GDP by the number of people living in the country.
  • On a broad level, GDP can, therefore, be used to help determine the standard of living.
  • However, economists often make adjustments to GDP, such as using real GDP, or use alternative methods for determining the standard of living.
  • Generally, rising global income translates to a higher standard of living, while diminishing global income causes the standard of living to decline.

Application and Shortcomings

While the standard of living is a complex topic with no universally objective measurement, rising global income since the Industrial Revolution has undeniably been accompanied by global poverty reduction, improved life expectancy, increased investment in technology development, and a high material standard of living in general.

GDP is divided by population to determine personal income, adjusted for inflation with real GDP, and adjusted for purchasing power parity to control for the impacts of regional price disparities. Real per capita GDP adjusted for purchasing power parity is a heavily refined statistic used to measure true income, which is an important element of well-being.

Real GDP, which measures economic growth minus the impact of inflation, is seen as a more accurate representation of economic growth than nominal GDP.

GDP shrank by an annualized five percent rate in the first quarter of 2020, reflecting the impact of the COVID-19 pandemic. It was the biggest quarterly drop in GDP in 11 years, since late 2008, amid the credit crisis.

The Human Development Index

Many economists and academics have observed that income is not the only determinant of well-being, so other metrics have been proposed to measure the standard of living. The Human Development Index (HDI) was developed by economists in association with the United Nations Development Programme, and this metric includes measurements of life expectancy and education in addition to per capita income.

Prior to 2010, GDP was a direct input in the official calculation of HDI, but it has since changed to gross national income (GNI). There are also adjustments to HDI that account for such variables as income inequality.