GDP is often considered as in index of welfare of the people. Welfare means sense of material well-being among the people. It depends on greater per head availability of goods and services. So, higher GDP is generally taken as greater welfare of people.
However, this generalization may not be correct due to following limitations or reasons.
1. Distribution of GDP:- It is possible that with rise in GDP, inequalities in the distribution of income may also increase, i.e., the gap between rich and poor increases (i.e., rich become more rich and poor become more poor). So, if with rise in GDP, inequality increases, then welfare of the people may not rise as much as the rise in GDP.
2. Change in prices:- If increase in GDP is due to rise in prices and not due to increase in physical output, then it will not be a reliable index of economic welfare.
3. Non-monetary exchanges:- Many activities in an economy are not evaluated in monetary terms. For example, non-market transactions like services of housewife, kitchen gardening, leisure time activities, etc. are not included in GDP, due to non availability of data. However, such activities influence the economic welfare.
4. Externalities:- Externalities refer to benefits or harms of an activity caused by a firm or an individual, for which they are not paid or penalised. Activities which result in benefits to others are termed as positive externalities and activities result in harm to others are termed as negative externalities.
Example and Impact of Negative Externality: Environmental Pollution caused by industrial plants. Such pollution reduces the welfare through negatrive effect on health.
Example and Impact of Positive Externality: Use of public parks by the people for pleasure for which no payments are made by the public. It increases welfare through positive effect on health.
Such external effects doe not form part of market transactions. GDP does not take into account externalities, positive or negative.
Rate of population growth:- GDP does not consider the changes in the population of a country. If rate of population growth is higher than the rate of growth of GDP, then it will decrease the per capita availability of goods and services, which will adversely affect teh economic welfare.
Composition of GDP: Higher GDP will promote welfare only if increased output comprises of goods of mass consumption and essential goods. Increase in production of war goods does not lead to any direct increase in the welfare of people. So, composition of GDP also affects Welfare.
Finally, it can be concluded that GDP may not be taken as a satisfactory measure of economic welfare due to above mentioned limitations, yet it does reflect some index of economic welfare.