Gross domestic product (GDP) is the sum total of value of goods and services created within the geographical boundary of a country in a particular year. It gets distributed among the people as incomes except retained earnings.

So, we consider that higher level of GDP of a country is an index of greater well being of the people of that country. Welfare of a country means well being of entire population of the country. But there are certain limitations of using GDP as an index of welfare of a country. 

They are as follows:

1. Distribution of gross domestic product (GDP): Generally, the rise in GDP will not represent increase in the welfare of the country. If the GDP of the country is rising, the welfare may not rise as a consequence. This is because the rise in gross domestic product may be concentrated in the hands of very few individuals or firms. For the remaining, the income may, in fact, might have decreased. In such a situation, the welfare of the entire country cannot be said to have improved.

2. Non-monetary exchanges: Some of the activities in a country are not evaluated in terms of money. For instance, the domestic services of housewife are not paid for. The exchanges which take place in the informal sector without the help of money are called barter exchanges. In barter exchanges, goods are directly exchanged against each other.

As money is not used here, these exchanges are not registered as part of economic activity. In India, because of many remote areas, these kinds of exchanges still take place and they are generally not counted in the GDP. Therefore, gross domestic product calculated in the standard manner may not give us a clear indication of welfare of a country.

3. Externalities: An externality is a cost or benefit conferred upon second or third parties as a result of acts of individual production and consumption. In other words, externalities refer to the benefits or harms, a firm or an individual causes to another for which they are not paid or penalized. These do not have any market in which they can be bought and sold.

But the cost or benefit of an externality cannot be measured in money terms because it is not included in market activities. For example, the pleasure one gets from his neighbour’s garden is an external benefit and external cost is environmental pollution caused by industries. Both are excluded from national income estimates.

4. Leisure and work: One of the important things that affect the welfare of a society is leisure. But is not included in GDP. For example, longer working hours may make people unhappy because their leisure is reduced. On the contrary, shorter working hours per week may increase leisure and make people happy.

5. Manner of production: The economic welfare also depends on the manner of production of goods and services. If goods are produced by child labour or by exploitation of workers, then the economic welfare cannot increase.