Question

6.5. Does Spending Measure Welfare? Suppose a community spends $1 million on salaries and equipment for its police department. Because it believes that citizens are now more law-abiding, the community decides to cut back on the number of police it employs. As a result, the community now spends $800,000 less on police officers. The crime rate remains the same.

a. What happens to measured GDP?

b. Does GDP accurately reflect welfare in this case?

Discuss the underlying issue that this example poses.

Answer 1

(a) Measured GDP will decrease by $200,0000

(b) No

Explanation:

(a) Gross Domestic Product (GDP) is the total value in monetary terms of al the goods produced in a geographic location.

There will be a $200,000 decrease in the value of the GDP of the community as a result of reduction in the community spending from $1 million to $800,000.

(b) Generally, GDP is not a true indicator of welfare, likewise in this case, GDP does not reflect the welfare of the community.

There's a decrease in the community spending from $1 million to $800,000 but there's an increase in the welfare of the community as a result of decrease in crime rate.