<p>Your friend is right that GDP and similar measures are flawed—or, at least, <em>incomplete</em>. But this isn't exactly news to economists!</p>

<p>For example, Richard Easterlin <a href="https://en.wikipedia.org/wiki/Easterlin_paradox" rel="nofollow noreferrer">was arguing in the 1970s</a> that GDP is a poor measure of national well-being. The specific issues with GDP that you point out in your question (failure to account for the value of innovations or for free products, etc.) are so well-known that they now make it into <a href="https://www.tutor2u.net/economics/reference/10-flaws-in-gdp-as-a-measure-of-living-standards" rel="nofollow noreferrer">tutorials aimed at high school students</a>. For a more recent take on the issue, here is a <a href="https://www.escoe.ac.uk/wp-content/uploads/2017/02/ESCoE-DP-2017-01-1.pdf" rel="nofollow noreferrer">discussion paper</a> on the topic of technology and GDP measurement (the author also has a book on the topic of GDP as a measure).</p>

<hr>

<p>To be a little bit more concrete about <strong>how</strong> economists know the measure is flawed, let's look at how economic theory helps us to set objectives and guides us in measuring our performance in a simple example.</p>

<p>Economics as a body of knowledge suggests variables of interest to a policymaker. Suppose, for the sake of illustration, we are concerned only with maximising peoples' material well-being. We know that we can get a measure of material welfare by computing the area bounded by the general equilibrium demand curve and supply function. So, in an ideal world, we would just measure this total surplus and pursue policies that increase it. For a variety of reasons, this quantity is difficult to measure—especially at the aggregate level over time.</p>

<p>The 'next best' alternative is to use the economic model to tell us what variables influence this surplus, and then try to measure those variables instead. Obvious examples of such variables are income (which expands demand possibilities) and technology (which expands production possibilities). Broadly speaking, if income is going up and technology is improving then the surplus (which is what we are actually interested in) should also be increasing.</p>

<p>It is important to keep an eye on both variables because the theory tells us that surplus can rise as income falls if, for example, technology is improving fast enough (just think about the extreme case where technology is so good that we can produce everything costlessly; then price and income would be zero, but surplus from consumption would nevertheless be very high).</p>

<p>With this framework in mind, it is very natural to look at GDP and say: "This is a measure of income, which is a part of the picture. But it is missing another component (technology) that we know, from theory, is also important."</p>

<hr>

<p>If measures like GDP are known to be so flawed, why are they used? It is important to understand that no serious economist cares about GDP per se. Instead, economists stress the importance of a portfolio of policies that work together to improve overall well-being of the populace. There are many factors that weigh on well-being. These include income and productivity (which will show up in GDP), but also technological innovation, environmental improvement, improved health outcomes, reduced inequality, and so on. </p>

<p>Given these objectives, some way is needed to measure the efficacy of policy. Because the agenda is multi-faceted, we need enough indicators to measure the various dimensions we are interested in. GDP is useful because it is a widely-available measure of one part of what economists are interested in (material wellbeing). But this should not be confused with a situation where GDP is the objective in its own right. Nor should it be thought that economists have no interest in improving upon this measure.</p>

<p>The monomaniacal fixation with GDP is really a trait of the media and politics rather than practicing economists. </p>

CC BY-SA 3.0
2018-02-15T08:47:43.533Z
I like your answer but does it really answer econjohn's question? The answer basically argues that GDP is insufficient and economists know this. The question to me seemed to be *how*  we can tell whether a variable is relevant, not whether GDP was relevant.
Maarten Punt
CC BY-SA 3.0
2018-02-15T09:27:51.453Z
@MaartenPunt Your point is well taken. I have added a section to the answer with an example of how economics tells us what we should be measuring (in an ideal world), and therefore lets us evaluate the measures we actually have available.
Ubiquitous
CC BY-SA 3.0
2018-02-15T19:06:58.787Z
Looks way better. Thanks for that. I'd +1 the answer, but had already done so before the edits....
Maarten Punt
CC BY-SA 3.0
2018-02-13T17:23:30.653Z
2018-02-15T09:26:55.190Z
2018-02-15T09:26:55.190Z
Ubiquitous
<p>I have a colleague who is a mathematician by training and currently works in Risk Analysis. He has issues with current Economic theory and I have debated him over coffee a couple of times.</p>

<p>One question he asked stood out to me as I could not answer it.</p>

<blockquote>
  <p><strong>In terms of economic measurement, how does one know if the variables economists are looking at are relevant to the economic health of a country in a post industrial economy?</strong></p>
  
  <p>i.e.people and firms consume and produce many services that barely make a dent in the GDP, like how some medications and computers today are much cheaper today than when they first arrived on the market.</p>
</blockquote>

CC BY-SA 3.0
2018-02-13T12:11:06.417Z
The winning entries to the [Indigo Prize 2017](http://global-perspectives.org.uk/indigo-prize/indigo-prize-winners-2017/)  are of relevance.
Adam Bailey
CC BY-SA 3.0
2018-02-14T21:50:29.580Z
@MaartenPunt I suggest you post us comment on Ubiquitous's answer as users are not not notified if tagged.
EconJohn
CC BY-SA 3.0
2018-02-15T08:52:16.417Z
@EconJohn Did that just now. I originally placed it here, as the question is basically yours, and I didn't know if you found Ubiquitous answer sufficient. I thought you might not, given that you haven't accepted it, but perhaps I just interpreted your question wrong and I didn't want to whine over a minor point.
Maarten Punt
<soft-question>
Soft Question: Economic measurement in a post-industrial economy
EconJohn
# Soft Question: Economic measurement in a post-industrial economy

(Asked by: username_0 on 2018-02-13)

I have a colleague who is a mathematician by training and currently works in Risk Analysis. He has issues with current Economic theory and I have debated him over coffee a couple of times.

One question he asked stood out to me as I could not answer it.

> **In terms of economic measurement, how does one know if the variables economists are looking at are relevant to the economic health of a country in a post industrial economy?**
>
> i.e.people and firms consume and produce many services that barely make a dent in the GDP, like how some medications and computers today are much cheaper today than when they first arrived on the market.

**Tags:** soft-question

> **Comments:**
> **username_1**: The winning entries to the [Indigo Prize 2017](http://global-perspectives.org.uk/indigo-prize/indigo-prize-winners-2017/)  are of relevance.  
> **username_0**: @MaartenPunt I suggest you post us comment on username_3's answer as users are not not notified if tagged.  
> **username_2**: @username_0 Did that just now. I originally placed it here, as the question is basically yours, and I didn't know if you found username_3 answer sufficient. I thought you might not, given that you haven't accepted it, but perhaps I just interpreted your question wrong and I didn't want to whine over a minor point.  

---

## 1 answers

### Answer by username_3 on 2018-02-13. Score: 5 | Accepted answer

Your friend is right that GDP and similar measures are flawed—or, at least, *incomplete*. But this isn't exactly news to economists!

For example, Richard Easterlin [was arguing in the 1970s](https://en.wikipedia.org/wiki/Easterlin_paradox) that GDP is a poor measure of national well-being. The specific issues with GDP that you point out in your question (failure to account for the value of innovations or for free products, etc.) are so well-known that they now make it into [tutorials aimed at high school students](https://www.tutor2u.net/economics/reference/10-flaws-in-gdp-as-a-measure-of-living-standards). For a more recent take on the issue, here is a [discussion paper](https://www.escoe.ac.uk/wp-content/uploads/2017/02/ESCoE-DP-2017-01-1.pdf) on the topic of technology and GDP measurement (the author also has a book on the topic of GDP as a measure).

---

To be a little bit more concrete about **how** economists know the measure is flawed, let's look at how economic theory helps us to set objectives and guides us in measuring our performance in a simple example.

Economics as a body of knowledge suggests variables of interest to a policymaker. Suppose, for the sake of illustration, we are concerned only with maximising peoples' material well-being. We know that we can get a measure of material welfare by computing the area bounded by the general equilibrium demand curve and supply function. So, in an ideal world, we would just measure this total surplus and pursue policies that increase it. For a variety of reasons, this quantity is difficult to measure—especially at the aggregate level over time.

The 'next best' alternative is to use the economic model to tell us what variables influence this surplus, and then try to measure those variables instead. Obvious examples of such variables are income (which expands demand possibilities) and technology (which expands production possibilities). Broadly speaking, if income is going up and technology is improving then the surplus (which is what we are actually interested in) should also be increasing.

It is important to keep an eye on both variables because the theory tells us that surplus can rise as income falls if, for example, technology is improving fast enough (just think about the extreme case where technology is so good that we can produce everything costlessly; then price and income would be zero, but surplus from consumption would nevertheless be very high).

With this framework in mind, it is very natural to look at GDP and say: "This is a measure of income, which is a part of the picture. But it is missing another component (technology) that we know, from theory, is also important."

---

If measures like GDP are known to be so flawed, why are they used? It is important to understand that no serious economist cares about GDP per se. Instead, economists stress the importance of a portfolio of policies that work together to improve overall well-being of the populace. There are many factors that weigh on well-being. These include income and productivity (which will show up in GDP), but also technological innovation, environmental improvement, improved health outcomes, reduced inequality, and so on.

Given these objectives, some way is needed to measure the efficacy of policy. Because the agenda is multi-faceted, we need enough indicators to measure the various dimensions we are interested in. GDP is useful because it is a widely-available measure of one part of what economists are interested in (material wellbeing). But this should not be confused with a situation where GDP is the objective in its own right. Nor should it be thought that economists have no interest in improving upon this measure.

The monomaniacal fixation with GDP is really a trait of the media and politics rather than practicing economists.

> **Comments:**
> **username_2**: I like your answer but does it really answer econjohn's question? The answer basically argues that GDP is insufficient and economists know this. The question to me seemed to be *how*  we can tell whether a variable is relevant, not whether GDP was relevant.  
> **username_3**: @MaartenPunt Your point is well taken. I have added a section to the answer with an example of how economics tells us what we should be measuring (in an ideal world), and therefore lets us evaluate the measures we actually have available.  
> **username_2**: Looks way better. Thanks for that. I'd +1 the answer, but had already done so before the edits....  

---

