Question

Meera and Shahid are two classmates, who were comparing India's economic growth over the years. Meera referred to the increase in Gross Domestic Product (GDP) at current prices prevailing in market, while Shahid insisted on considering GDP after adjusting for inflation. Their debate on which of the two measures gives a true picture of people’s well-being, remained inconclusive. Considering the above mentioned situation, elaborate with valid reason, which of the two variables is considered a better indicator of welfare and why?

Hint:

Real GDP, adjusted for inflation, is a more accurate measure of economic growth and welfare as it reflects the actual increase in goods and services, rather than just price increases.

Answer 1

Step 1: Distinguishing between the two GDP types.
Meera is looking at Nominal GDP (GDP at current prices), which can rise simply because prices went up, even if production stayed the same. Shahid is advocating for Real GDP (GDP at constant prices), which keeps prices fixed to a base year to isolate changes in actual physical output.
Step 2: Analyzing the welfare aspect.
Welfare is tied to the availability of goods and services per person. If Nominal GDP doubles only because prices doubled, people are not better off—they are just paying more for the same amount of stuff. Real GDP increases only when the volume of production grows.
Step 3: Final Verdict.
Real GDP is a far superior indicator of economic welfare. It eliminates the "monetary illusion" caused by inflation and reflects the actual growth in the quantity of resources available to the citizens.