Why we're very much richer than the GDP numbers tell us we are


We're continually told that GDP isn't actually all that good at measuring how well off we really are. It doesn't measure the costs of pollution, it covers only market activity, it doesn't look at the distribution of wealth or income and so on. All of those things are true. But it's also true that GDP measures grossly underestimate how well of we all are collectively as well. The reason is contained in that chart above.  Because GDP is only measuring matters at that equilibrium price.

That means that the producer surplus, the profits, gross margins, what have you, are included in GDP. But that consumer surplus is not.

An example of what is meant here. Your humble author lives in rural Portugal where the mains water supply comes from the City. The pricing system is sensible, possibly even rational, for a drought prone area. There's a low and fixed cost, some €20 a month, for a basic water supply. This covers the usuals for the average household, drinking, washing, cleaning, bathing, but no more. If you want to use more water, say to fill a pool, one must pay extra. And one pays more per unit of water the more one uses. Try to irrigate a substantial garden and that will costs hundreds of euros a month (and we certainly check for leaks now given that a jammed toilet cistern led to a €300 bill).

However, what are we really prepared to pay for water? We've lived in places where the tap water was not, at least not to those immune to various bugs, actually potable. At such times we were absolutely delighted to pay, say, €1 a litre for the 4 litres a day that a couple of adults might get through. Bathing water from the tap but drinking water from the bottle.

So we'd be perfectly happy, if no other method were available, to pay €120 a month for just our drinking water. Well, perhaps not happy, but we'd do it: and the important thing here is that we're now being charged €20 and getting all our bathing, washing etc water for free.

We have a consumer surplus of €100 a month,at least, something that is vastly greater than the €20 a month that is recorded in the GDP figures, and that €100 isn't appearing anywhere at all in the national accounts. As far as the usual measures of wealth and or income, even of living standards, we're just not noting that number at all.

It's very difficult to actually prove this following statement because no one can accurately measure that consumer surplus. The amount that people would be willing to pay if they had to but which they do not because of that equilibrium price. For if it could be worked out accurately, and who would pay the extra would be, then firms would be doing their darndest to charge those different amounts and thus turn the consumer surplus into producer surplus. In rather the manner that VW sells essentially the same car under the Skoda, VW, Audi, Porsche and even Bentley brands. Tart it up, slap a different badge on it and see if you can get someone to pay more for it: product differentiation to attempt to capture some of that consumer surplus. But it's arguable that that consumer surplus is, across the economy, many times the actual recorded GDP, as it is in the worked out example of water supply.

One more point about the very modern world. We're getting a lot of things for free these days, things that we used to have to pay for. That equilibrium price, that market price, is therefore falling, so therefore so is the contribution to GDP of those things that are becoming free. Music streaming, messaging, information search and so on. But the consumer surplus of these things is just as vast, if not perhaps greater, than that water example.

So yes, GDP isn't a very good method of judging how well off we are. For we've now got the absurd fact that as the consumer surplus grows with free things, we're actually recording lower GDP at the same time. We're all getting richer but the numbers say we're getting poorer.