Gross domestic product (GDP) refers to the money value of all the final goods and services produced with in domestic territory of a country during a financial year inclusive of consumption of fixed capital or depreciation.

Welfare means sense of material well being among the people. This depends upon greater availability of goods and services. So it may be concluded that higher level of GDP is an index of greater well being of people. But this generalisation is not correct due to some limitations.

Limitations of GDP as a measure of economic welfare-

i) Distribution of GDP- If with increase in GDP inequality of income increase, poor become poorer while rich become richer. This may lead to decline in welfare even though GDP has increased.

ii) Non-monetary transactions- GDP remains underestimated as non-monetary transactions like services of housewife, barter exchanges, enjoyment from hobbies like gardening, painting etc. are not included in GDP. Although they increase economic welfare.

iii) Composition of GDP- If GDP increases due to more production of war goods like weapons, tanks etc. it will not increase economic welfare.

iv) Externalities- Externalities refer to the benefits (or harms) a firm or an individual causes to another for which they are not paid (or penalized). Externalities do not have any market in which they can be bought and sold. Such as carrying out the production of refinery may also be polluting the nearby river and create pollution. This may cause harm to the people who use the water of the river. Such harmful effects that the refinery is inflicting on others, for which it does not have to bear any cost, are called externalities. Therefore, if we take GDP as a measure of welfare of the economy we shall be overestimating the actual welfare. This was an example of negative externality. There can be cases of positive externalities as well. In such cases GDP will underestimate the actual welfare of the economy.