Economics (0455) | Living standards

Welcome to Chapter 5.1: Living Standards!

Hi there, future economist! This chapter is all about answering a crucial question: How well off are the people in a country?
When we study macroeconomics, we look at things like GDP, but that doesn't tell the whole story. To understand Economic Development, we need to look beyond raw numbers and examine the quality of life.
Don't worry if you find some of the measures confusing—we will break down the two main tools economists use (GDP per head and HDI) and see why comparing countries is often tricky!

Section 1: Defining Living Standards

1.1 What are Living Standards?

Living standards refer to the level of wealth, comfort, material goods, and necessities available to a certain socioeconomic class or a certain geographic area.

Economists generally divide living standards into two main parts:

• Material Living Standards: This refers to the access people have to physical goods and services. This is mostly measured using income and consumption (the financial aspects).
• Non-Material (Quality of Life) Standards: This refers to non-financial factors that affect well-being, such as health, education, security, and environmental quality.

Section 2: Indicators of Living Standards

2.1 Indicator 1: Real GDP per Head (Capita)

This is the most common way to measure material living standards. Before we look at it, remember what GDP is: the total value of all goods and services produced in an economy over a year.

Why We Use 'Real' and 'Per Head'

• Real GDP: We must use Real GDP because it has been adjusted for inflation (rising prices). If prices double, nominal GDP doubles, but you aren't actually producing more. Real GDP allows meaningful comparison over time.
• Per Head (Capita): If a country’s GDP is high but its population is huge, the average person might still be poor. Dividing by the population gives us the average income or output per person, allowing fair comparison between countries of different sizes.

The calculation is simple:

$$ \text{Real GDP per head} = \frac{\text{Real GDP}}{\text{Population}} $$

Advantages of Using Real GDP per Head

1. Widely Available: Almost every country measures GDP, making international comparisons possible.
2. Easy to Calculate: The formula is straightforward.
3. Measures Economic Output: It provides a good measure of the total production capacity of the economy.

Disadvantages of Using Real GDP per Head

This indicator has significant weaknesses because it ignores non-material standards and distribution issues:

1. Ignores Income Inequality: It is an average. A high GDP per head could be misleading if most of the wealth belongs to a very small number of people (e.g., the oil-rich monarchies).
2. Excludes Non-Marketed Activities: It ignores production that isn't sold in the market, such as subsistence farming (growing food just for your family) and unpaid household work. This is especially problematic in developing countries.
3. Ignores Externalities (Hidden Costs): GDP counts production but ignores costs like pollution, noise, or resource depletion. Producing more goods (higher GDP) might lead to a poorer quality of life (smoggy cities).
4. The Black/Informal Economy: GDP often misses illegal or unreported economic activities, meaning the true income of the country may be higher than recorded.
5. Doesn't Account for Leisure Time: If a country’s citizens work 80 hours a week, their GDP might be high, but their quality of life (leisure time) is low.

Did you know? If your neighbour helps you paint your house for free, it doesn't count towards GDP. If you pay him to do it, it does! GDP measures market transactions.

2.2 Indicator 2: The Human Development Index (HDI)

Because GDP per head is so limited in measuring actual well-being, the United Nations developed the Human Development Index (HDI).

The HDI is a composite measure (meaning it combines several factors) that ranks countries based on their level of human development. It ranges from 0 (lowest development) to 1 (highest development).

The Three Core Components of HDI

Remember the three components using the mnemonic L. E. G.:

1. Long and Healthy Life (Health): Measured by Life Expectancy at Birth.
2. Education: Measured by two factors:
   i) Mean years of schooling (actual average years spent in education)
   ii) Expected years of schooling (the number of years a child is expected to spend in school)
3. Good Standard of Living (Material Wealth): Measured by Gross National Income (GNI) per capita, adjusted for purchasing power parity (PPP).

Don't worry! You do not need to know the complex mathematical formula for calculating the final HDI score, only the components used.

Advantages of Using HDI

1. Broader Measure: HDI provides a much more holistic view of living standards than GDP alone, by including education and health outcomes.
2. Focuses on People: It highlights whether the income generated is actually translating into better lives (e.g., people living longer and becoming better educated).
3. Prioritizes Policy: It encourages governments to focus not just on economic growth, but also on social policies like healthcare and schooling.

Disadvantages of Using HDI

1. It is Still an Average: Just like GDP, the HDI is an average and does not show inequalities within the country (rich vs. poor regions).
2. Ignores Other Quality of Life Factors: It leaves out important aspects like political freedom, human rights, gender inequality, and environmental quality.
3. Data Reliability: In many developing countries, data for life expectancy and years of schooling can be hard to collect accurately.

Section 3: Comparing Living Standards and Income Distribution (5.1.2)

3.1 Differences in Living Standards Between Countries

The gap in living standards between rich (developed) and poor (developing) countries is massive. This is due to many deep-seated differences:

• Income Levels: Developed countries have consistently higher Real GDP per head, meaning more resources are available per person for consumption and investment.
• Productivity: Developed countries tend to have higher labour productivity (output per worker) because they use better technology, more capital (machines), and have highly skilled workforces.
• Population Growth/Structure: Many developing countries have rapid population growth and high dependency ratios (many children/elderly supported by fewer working people). This strains public services like schools and hospitals.
• Sector Size: Developing economies often rely heavily on the primary sector (agriculture), which offers low-value jobs and is vulnerable to weather changes. Developed economies rely on the high-value tertiary (services) and secondary (manufacturing) sectors.
• Education and Healthcare: Low-income countries often have poorer access to or lower quality education and healthcare, which lowers future productivity and life expectancy (lowering their HDI scores).

3.2 Differences in Living Standards and Income Distribution Within Countries

Even if two countries have the same average GDP per head, their citizens might experience very different living standards if their income distribution varies.

Understanding Income Distribution

Income Distribution describes how a nation’s total income is spread among its population. If income is distributed very unevenly, it means there is high income inequality.

Example: Country A has 10 people. 9 earn \$10,000 and 1 earns \$110,000. The average income is \$20,000. But 90% of the population lives on half the average!

Reasons for Differences in Earnings and Income (Inequality)

Differences in earnings create differences in living standards within a single country. These reasons include:

1. Skills and Education: Workers with high-demand skills (e.g., doctors, programmers) command higher wages than unskilled workers.
2. Inheritance: People who inherit large amounts of wealth or assets (like property) start life with a significant economic advantage.
3. Type of Job/Sector: Jobs in the private sector (especially management roles) often pay more than comparable jobs in the public sector (government workers).
4. Relative Bargaining Power: Workers who are members of strong trade unions can negotiate better wages and conditions than isolated workers.
5. Discrimination: Historically, women, minorities, or certain ethnic groups may face wage discrimination, earning less for the same job.

Key Takeaway: High national wealth does not automatically mean high living standards for everyone. The degree of income inequality determines who benefits from that wealth.