Why GDP can Decline with Improvements in Quality of Life

Quality of life decreases along with declines in Gross Domestic Product (GDP) due to an intrinsic correlation between the two. Consequently, GDP is the only measurement of progress needed. This article will expand upon the connection between GDP and quality of life in addition to illustrating why GDP is the more important of the measurements.

'Progress' is a relative term open to debate and depending on who one asks. However, if the concept of more is tied with progress, then more productivity as measured by Gross Domestic Product is not the only metric a society can attain increases in. More happiness, more health, more freedom, more rights etc. are all gains in life some might consider progress. 

A significant question of possibility emerges out of this divergent view of progress however. Specifically, can progress be sustained if other metrics of progress besides GDP and related measurements such as Job growth are not the only indicators of progress? In other words, can productivity continue grow side by side with other types of progress? After all, people might get lazy when they're happy so having more of other things considered progress might just be counterproductive to progress. This article will discuss other types of progress side by side with GDP in light of the above considerations.

Since Gross Domestic Product measures the total output of goods and services produced by a country, that measurement is a measurement of total material wealth produced for a given year as valued by currency prices for the cost of those goods and services. The first question one might ask is ,if the GDP were to decline, could other aspects of 'progress' continue to rise? For example, if there is less medical equipment, fewer doctors produced, less health care services etc. one can draw the connection progress in health care may also decline along with the decline in GDP if such GDP declines are comprised of declines in health related products and services. The result becomes less progress in this case, and may be further debilitated by declines in production related to other aspects of the economy.

To further illustrate, progress is linked to the economy and the economy is measured by GDP. While GDP is not the only measurement of an economy, it is a key indicator of the wealth available to a 'population'. The less wealth there is, the lower the standard of living becomes. Since standard of living is related to quality of life, a decline in GDP which is a measure of standard of living means there is likely to be a correlation between GDP and quality of life. So from this perspective, GDP is a measurement of quality of life in so far as the two are related. So why then does the question of quality of life indicators even arise? This is a good question.

The need for quality of life indicators can be thought of as a cry for help regarding disproportionate distribution of Gross Domestic Product. To illustrate, if everyone were to suddenly become rich, a great majority may find it simply unnecessary to work, or their productivity would decline in their lack of need to work. After a short while, inflation would rise, GDP would decline due to so many people being rich, and the quality of life would fall. Granted, some may still be motivated to work for love of labor, and other forms of gain such as social status, or even some kind of ethical conviction. However, the principles of human nature tell us, we are motivated by greed and that greed includes greed for a worry free life. That worry free life would end up leading to a decline in the overall quality of life.

So how can this apparent paradox between GDP and quality of life be solved? That is another question for another day. For the time being, one might realize quality of life is merely the call for more share of the GDP. If one is still not convinced of this relationship consider the notion of quality of life further. Love, comfort, harmony, amenities, entertainment, luxury, services etc. can't all be bought with money but certainly can be facilitated by wealth. 

Since wealth is measured by GDP at the macro-economic level, the correlation between the two is theoretically sound. As we have seen, a micro-economic distribution of GDP that is spread more evenly, has a strong possibility of leading to a decline in GDP and thus quality of life. Human nature is at the bottom of issue but who has the time to worry about that when everyone is chasing the GDP?

What Indifference Curves are in Economics

Some economists say happiness can't be measured, but indifference curves come pretty close to doing just that by measuring consumer preference for products. For businesses this can help an owner, investors or managers determine how much their products or services are valued in relation to an alternative. In turn, pricing and marketing decisions can be made using indifference curves to optimize revenue.

Indifference curves are plotted on an indifference graph with an X and Y axis i.e. vertical and horizontal lines. The X axis represents the amount of product A, and the Y axis the same for product B. If Mr. Jones, really likes product A, then the decline in marginal utility by having more of product A than B will be slight and represented by a steeper indifference curve. Additional curves can be added to represent indifference for two products at different price levels.
If Mr. Jones values both product A and product B equally, the indifference curve will take on a more triangular shape in terms of the X and Y axis. The indifference curve is determined by plotting volume of preference for item A if no B items are used, then re-plotting the amount of A, if one unit of B is purchased and so on until all that is left are B items.

Suppose Mr. Jones enjoys red apples more than green apples. Since he likes red apples the prospect of obtaining one green apple in exchange for one red apple is not pleasing. Thus, in order to give up a red apple, Mr. Jones will require 2 green apples. This leads to a steeper slope than a one for one exchange. By listing purchase statistics on  a spreadsheet when price changes take place, the information for an indifference curve becomes available. 

Indifference curves are useful tools for businesses because they can be used to monitor consumer preferences via purchase patterns. If it becomes evident that red apples are more favored for example, an apple retailer may choose to raise the price of apples and lower the price of green apples as consumers may choose to buy the red apples regardless of a small price increase. This is the elasticity of demand.

To illustrate further, if sales of red apples remain the same with a price increase based n the indifference curve,  then the retailer has made a good decision. However, what if he lowers the price of red apples? Would this lead to a purchase of more apples, and if so would that amount to more profit than had the price remained the same or if it had been raised? To determine this the profit for each apple sold at each price level must be multiplied by the number of apples sold.

Sources:

1. http://bit.ly/eVWc2E (Cornell University)
2. http://bit.ly/gkr7Rs   (Investopedia)

Introduction to the IS-LM Model in Economics

In terms of business, the IS/LM model in macroeconomics can help in assessing the likelihood of higher sales revenue using macroeconomic data. This can be done by testing statistical relationships against revenue using time sequenced macroeconomic data as projected through the IS-LM model.

What the IS/LM model should reveal to you is where an economy stands in terms of income, savings, interest rates and investing. Moreover, the IS/LM model in macroeconomics illustrates the relationship between these variables and at what levels they are balanced and steadier.  The IS represents income and spending, while the LM refers to lending and money supply.

The IS/LM model is the convergence of two economic graphs, one representing income and savings (IS) and the other money supply and demand. Interest and income are key variables in both curves i.e. According to 'The Economics of Keynes' by Mark Hayes, in the IS curve, interest is the independent variable meaning it influences the dependent variable of income.

In the LM curve, income is the independent variable that influences interest rate. However, also according to Hayes, related independent variables proposed by Keynes, the famous economist are lost in the IS/LM model. Hayes states these independent variables to be consumption, liquidity and income. Yet despite this it does seem evident the IS/LM model includes liquidity as a bi-product of low interest rates, and consumption a result of higher income.

To illustrate it helps to look at a graphs and explanations of the IS/LM model in macroeconomics. When changes in one variable take place, reactions in the other occur. For example, if the interest rates for savings increases, so does income that can affect investment and spending or the demand for money.

When the IS curve shifts to the right it means conditions are more favorable for businesses because there is more income, and a higher demand for money which is reinvested. When the IS curve shifts to the left, interest rates have declined, personal savings decreases, and demand for money has declined.

In a sense the IS/LM model is an economic indicator if how interest rates and income relate to investments and savings on a scale of Gross Domestic Product (GDP) and real interest rates. The steeper the angle of the LM curve, the more dramatically interest rates are tied to demand for money.

The IS/LM model in macroeconomics is also used to graph the affect of government fiscal policy on income, spending and GDP. If government spending is affective, the IS curve should lead to higher interest rates, increased GDP, and a rise in spending and income which also corresponds to an increase in demand and cost for money.

Just because an IS curve moves to the right doesn't necessarily imply it will benefit a business because it is a macroeconomic model. Macroeconomic models aren't directly related to single economic entities or variables, but rather are a composite or aggregate metric of such.

Sources:

1. http://bit.ly/hMmjJ1   (Roubini and Backus)
2. http://bit.ly/dLNmSK (Berkeley)
3. http://bit.ly/hZJMpI    (M. Hayes)