Posts tagged external

Limitations of GDP (Gross Domestic Products)

Many economists rely on GDP (Gross Domestic Products) to analyze and compare economies. However, there are several limitations of GDP as all macroeconomic statistics do.

One of the limitations is that ‘nominal’ GDPs do not take into account that there are inflations and deflations. So let’s say that there was 10% inflation and the GDP increased 10%. Some could say that GDP has increased by 10% and that is economic growth. However, it these people didn’t take into account that in fact inflation has caused this increase in GDP. So this is one of the limitation of ‘nominal’ GDP. There is another GDP called ‘real’ GDP that takes inflation/deflation out of the GDP and tries to measure the ‘true’ GDP of an economy.

The second limitation is that GDP does not measure negative externalities. For example, the CO2 emission produced by economic activity would not be considered in measuring GDP. Also, depletion of some resources are not considered either. So, this limitation is greatly criticized by ecological economists.

Another limitation is that GDP’s could change due to change in exchange rate to US dollar. Notice how GDP is calculated in USD. So GDPs of foreign countries would change due to their change in currency value. For example, Japan’s recent GDP would rose due to their strong yen. So, change in currency values could change the GDP. However, this is not the problem of United States because the country uses USD.

There is one last limitation to GDP. It is that GDP’s do not measure black markets and illegal economic transactions. For example, if some drug dealer sells $1 million dollar of drugs to some country this will not be counted in the GDP. Some people will say that these kind of economic activities would comprise only a meager proportion of GDP, however, United States, for example, has 10~20% of illegal black markets to its GDP.

In sum, these were the limitations of GDP. Despite these limitations, GDP is considered to be one of the best methods of measuring/comparing economies.


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Data Response: Trees

What are the external costs/benefits of trees?

(a) (i) Negative externality are the bad effects that are suffered by a third party when a good or service is produced or consumed.

(ii) Positive externalities are beneficial effects that are enjoyed by a third party when a good or service is produced or consumed.

(b) Graph 1: Negative Externality of Tree Branch

Branches falling in a neighbor’s yard could be considered a negative externality looking at several points. If branches from trees fall in a neighbor’s yard, the neighbor would have to take his/her time to clean the branches up. Many business people think of time as money. The time the neighbor has to take to clean up the branches could be converted to a monetary value. Also, the ‘labor’ of cleaning up the branches also could be converted to a monetary value. In addition, if a neighbor suffered psycologically by the constant falling of branches from his/her neighbor tree can be conpensated by money. However, many ‘modest’ or ‘ordinary’ neighbors would not complain about it fearing the relationship with his/her neighbor could get bad. As it is illustrated in the graph, the time, labor, and psycological suffering of falling branches is not reflected in the graph. So this falling of branches from the nieghbor’s tree could be considered a negative externality.

(c) Graph 2: Government Intervention to Stop Negative Externality

Government could intervene if a neighbor complains to the local authorities about this annoying branches. A government could put a tax on a neighbor’s tree for having these ‘significant’ negative externalities and put a curve of MPC up to MSC in the graph 1. Or, the government could persuade the neighbor to cut down trees or clean up the branches him/herself and move the curve of MPB down to MSB in graph 2.

(d) If a government taxes on the neighbor for the falling of branches, it eventually lower the number of branches falling on the poor neighbor’s garden, however there are some drawbacks. The neighbor getting taxed would have monetary loss for his/her tree’s wrongful acts. To explain this graphically, in the graph 1, the number of branches falling decreases, however, cost of branches falling increases. Therefore, it is hurting the neighbor of the wrongful tree. However, if the government persuades the person to either cut down trees or clean up the branches him/herself, it will both let both neighbors to benefit. The owner of the tree can still keep the tree and the neighbor would not have to suffer from the branches falling of the tree. As illustrated in graph 2, it both lowers the cost and quantity of falling branches. So the best way for the government to do is to persuade the owener of the tree to clean up the branches falling off from the trees.

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