Standard of Living

The overall level of comfort, well-being, and material prosperity experienced by a population which is typically measured by factors such as income and access to goods and services

Author: Osman Ahmed
Osman Ahmed
Osman Ahmed
Investment Banking | Private Equity

Osman started his career as an investment banking analyst at Thomas Weisel Partners where he spent just over two years before moving into a growth equity investing role at Scale Venture Partners, focused on technology. He's currently a VP at KCK Group, the private equity arm of a middle eastern family office. Osman has a generalist industry focus on lower middle market growth equity and buyout transactions.

Osman holds a Bachelor of Science in Computer Science from the University of Southern California and a Master of Business Administration with concentrations in Finance, Entrepreneurship, and Economics from the University of Chicago Booth School of Business.

Reviewed By: Andy Yan
Andy Yan
Andy Yan
Investment Banking | Corporate Development

Before deciding to pursue his MBA, Andy previously spent two years at Credit Suisse in Investment Banking, primarily working on M&A and IPO transactions. Prior to joining Credit Suisse, Andy was a Business Analyst Intern for Capital One and worked as an associate for Cambridge Realty Capital Companies.

Andy graduated from University of Chicago with a Bachelor of Arts in Economics and Statistics and is currently an MBA candidate at The University of Chicago Booth School of Business with a concentration in Analytical Finance.

Last Updated:November 28, 2023

What Is Standard of Living?

Standard of Living refers to the satisfaction derived from the available goods and services for a given population. This satisfaction encompasses not only material possessions but also less quantifiable aspects of life, such as happiness, life expectancy, and the quality of the living environment. Achieving a high standard of living is a significant goal in the overall economic strategy of a country.

It's crucial to recognize that a country's standard of living has a profound impact on various population factors, including happiness and productivity. The relationship is reciprocal: higher productivity and happiness levels contribute to an improved overall economy. Economists emphasize the direct link between a country's standard of living and its productivity. Communities that scale up their level of productivity have a higher probability of increasing their quality of life.

To gauge a country's standard of living, economists commonly use "real gross domestic product (GDP) per capita." This metric helps assess the overall well-being of a nation's citizens by considering factors like wealth, material possessions, healthcare accessibility, and education.

While both are crucial for evaluating citizen satisfaction and happiness, it's important to distinguish between the standard of living and quality of life. Some mistakenly use these terms interchangeably. Quality of life incorporates non-material factors such as happiness, satisfaction, freedom, and relationships, going beyond the tangible aspects considered in the standard of living.

The concepts of standard of living and cost of living serve distinct purposes. The standard of living provides a comprehensive analysis, considering wealth, material possessions, healthcare, and education. In contrast, the cost of living focuses on the monetary requirements for daily activities, including groceries, clothing, transportation, and healthcare costs.

Key Takeaways

  • The standard of living pertains to satisfaction from available goods and services, a macroeconomic goal for countries.
  • Productivity and happiness levels are directly linked to the standard of living, impacting the overall economy positively.
  • Real GDP per capita is a commonly used tool to measure the standard of living but has limitations, including overlooking wealth distribution and non-monetary contributions.
  • Distinct from the cost of living, the standard of living gauges overall wealth, material possessions, healthcare access, education, and citizens' ability to afford necessities and luxuries.
  • Alternative metrics like HDI, GNH, and GPI provide more comprehensive evaluations of living standards by considering non-economic factors and addressing GDP per capita limitations.

How is Standard Of Living Measured?

Real GDP per head figures are the primary indicator of living standards. For example, suppose a country's real GDP per head is higher this year than last year. In that case, this particular country's inhabitants will benefit from a higher living standard.

To better understand GDP/ head, let's look at the separate components that add to the above indicator.

1. GDP

The first component is the GDP which is the total value of all goods and services that a country generates in a specific period ( usually on an annual basis). We then adjust GDP for inflation (any price level changes), giving us the Real GDP.

2. Real GDP

We obtain Real GDP by adjusting for changes in the price level in a country. The next step is to divide the RGDP by the number of people living in a particular country which eventually yields the Real GDP/head.

Based on the above breakdown of Real GDP per Capita, we can say that the latter seeks to measure the average economic output of each resident in a country.

The formula for Real GDP per capita is as follows:

Real GDP Per Capita = [ Nominal GDP / ( 1 + Deflator )] / Population

Real GDP Per Capita = Real GDP / Population

From the above formula, nominal GDP is simply the GDP without accounting for inflation. 

The Deflator is the change in price level between 2 years (it is an economic tool used to adjust for inflation). The Deflator can be obtained online by searching the Bureau of Economic Analysis website.

For example, let's take a country like Singapore, whose real GDP per capita is rising. By this definition, the living standard of that country is also increasing. 

We can hence deduce that there is a likelihood that more goods and services are available to customers, and they are in a better position to afford them.

While Real GDP per capita captures the ability of people to enjoy the materialistic aspect of life, it still doesn't consider non-quantifiable components such as privacy, safety, and life expectancy. 

This statement, therefore, leads to the question of whether Real GDP per capita is a good measure or not.

Limitations Of Real GDP Per Capita As A Measure Of Living Standard

While GDP per capita is undoubtedly the most commonly used metric to assess living standard, it still fails to consider many factors that significantly impact an economy and an individual's quality of life.

Below are some of the limitations of GDP per capita as a measure of the quality of life:

1. Distribution of wealth

It does not consider the distribution of wealth and other forms of inequalities. 

To illustrate this, let's take a sample of 100 people from a particular country. If 50 residents produce $1M in economic output annually and the other half produces no output, the country's real GDP per capita is $20,000. 

GDP/ Capita = $1M/ 50 residents

Nevertheless, given that half of the sample taken produces no output, this implies that this category of people is experiencing low quality of life, even if the country they live in is experiencing a high living standard due to a high RGDP per capita.

2. Unpaid work

It does not account for non-economical transitions that do not involve monetary compensation.

The latter omits unpaid work such as community service, volunteer work, or other tasks that might contribute to improving a country's living standard but are not financially rewarded.

3. Changes in quality of life

GDP per capita fails to capture the intangible aspects that make up for the well-being and happiness of the citizens of a country. Those are mainly non-economic factors such as good health, low crime rate, and work-life balance.

Non-economic factors also influence people's quality of life. For example, an individual might be enjoying a high-income level and living in a bug house, but if he lives in an area surrounded by air or noise pollution, which is harming his health, this might lead to a fall in his quality of life.

4. Changes in quality of goods

While GDP captures significant-quality upgrades of large items like cars and computers, they do not account for more minor aspects, including better quality healthcare services or energy efficiency upgrades.

Even if the above metric has certain limitations as a measure of living standard, it is still widely used by economists given its ease at quantifying the various aspects that determine the quality of life in a country.

To get a complete measurement of the quality of life, we still need to quantify aspects such as air quality, inequality, safety, and life expectancy. 

To make this possible, we can use the HDI - Human development index and the GNH - Gross National Happiness.

Alternatives for measuring Standard Of Living

While the GDP per capita remains one of the most popular metrics to assess a country's living standard, some alternatives have been brought to the limelight in recent years to capture the effects of non-economic factors. Some other options are listed below:

1. Human Development Index (HDI)

The HDI states that people and their capabilities should be the main criteria for assessing the development of a country and not economic growth alone (rise in RGDP).

The above metric captures three critical dimensions of human development: a long and healthy life, a reasonable literacy rate, and a high living standard.

The Health dimension includes the life expectancy at birth. Next comes the literacy rate, which is the mean number of years of schooling for adults aged above 25 years as well as expected years of education for children of school entering age.

Lastly, the Standard of living dimension is the gross national income per capita.

2. Gross National Happiness (GNH) index

 The above metric takes into account nine factors to determine the living standard:

  • Psychological health
  • Physical health
  • Education
  • How residents use their time
  • Cultural diversity and resilience
  • Governance
  • Community vitality
  • Ecological diversity and resilience
  • Living standards

The Gross National Happiness index was first developed in 1972 by King Singye Wangchuck, the 4th king of Bhutan, and has subsequently been popularized in some policy circles.

3. Genuine Progress Indicator (GPI)

A US nonprofit public policy organization called Redefining Progress uses this metric. GPI uses GDP as the baseline for its test but omits factors like crime rate and family issues such as divorce and pollution.

GPI then includes non-profitable activities like household and voluntary contributions, which the GDP omits. 

The latter also seeks to adjust for income inequality. So we can say there is a direct relationship between GPI and poor people's share of income.

Factors Used in Evaluating the Standard of Living

The factors are:

1. Level of Productivity

Productivity is a measure of economic performance that compares the number of goods and services produced with the number of inputs employed to generate those goods and services.

There is a direct relationship between the number of goods and services a country generates and the Standard of living it can provide its inhabitants. The higher the productivity level of the citizens of a particular economy, the better off they shall be.

For instance, the higher the level of productivity of each person engaged in Healthcare or Agriculture, the higher will be the national output and hence the quality of life of those people. 

We can therefore say that variances in productivity have a significant impact when it comes to differences in the SOL of various countries.

For example, let's consider a worker in an advanced country like the US that uses high capital equipment in the production process and another from a developing country that works with smaller capital equipment.

In this case, the productivity level for the worker in the advanced country will be higher than for the less advanced one since using high-level capital equipment compared to a smaller one will enable him to produce more goods in a specific timeframe. 

In other words, developed countries use advanced technologies to produce goods and services while their under-developed counterparts are technologically backward.

2. Distribution of National Income

A country with high-income inequality signals that only a few people will benefit from a high living standard. Conversely, a large majority of its population will have a significantly low quality of life.

3. General Price Level

When determining an individual's quality of life, solely considering his monthly/ annual salary is not enough. Instead, it is better to see what that income can buy regarding goods and services - the real income.

4. Quality of Education

Another factor responsible for variances in the quality of life is the differences in the education level. The people who benefit from a high level of education are more likely to have a higher paying job than those with a lower level of education.

A country with many illiterate citizens cannot expect a high quality of life as they do not possess the skills and knowledge to engage in any activities that will improve the economy in which they live.

Even in an instance whereby the highly uneducated people were to have a large amount of money by either winning the lottery of inheritance, they would either hoard them or waste them on useless activities.

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Researched and authored by Alvin DookhonyLinkedIn

Reviewed and Edited by Justin Prager-Shulga LinkedIn

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