Chapter-21

Economic growth:
Economic growth is an increase in the production of economic goods and services in
one period of time compared with a previous period.
It can be measured in nominal or real (adjusted to remove inflation) terms. Traditionally,
aggregate economic growth is measured in terms of gross national product
(GNP) or gross domestic product (GDP).
Rates of change of real Gross Domestic Product (GDP) as a measure of economic
growth:

Gross Domestic Product (GDP):

Gross domestic product (GDP) is one of the most widely used indicators of economic
performance. GDP measures a national economy's total output in a given period and is
seasonally adjusted to eliminate quarterly variations based on climate or holidays. The
most closely watched GDP measure is also adjusted for inflation to measure changes in
output rather than changes in the prices of goods and services.
In other words, gross domestic product tracks the health of a country's economy. It
represents the value of all goods and services produced over a specific time period
within a country's borders.
GDP (Gross Domestic Product) measures the value of all final goods/services produced
in an economy in a year.
There are two methods used to work out the GDP value of an economy. The first one is
the expenditure method. In the expenditure method there are four main components
that are added up in order to get the GDP value. These include: Consumer expenditure,
Investment, Government spending and Net trade (exports – imports).
The other method is called the income method, which involves adding up all the
incomes within an economy (wages, interest, profits and rents).
The GDP value from the income method and expenditure method should always be the
same. For example, consumers earn money through working for firms (income), they
then spend this income on goods/services (Expenditure). If a firm’s revenue exceeds
their costs then they will earn a profit (Income) which they then may spend to hire more
employees or expand their business (expenditure).
The following formula can be derived from this fact: Income = Output = Expenditure. As
a result of this, when GDP raises so do incomes which some may suggest points to an
increase in living standards.

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Real GDP and nominal GDP:
Nominal GDP is the value of final goods/services within an economy without adjusting
for inflation. Real Gross domestic product is the same as GDP but takes into account
inflation.
For example, if the value of goods/services within an economy (GDP) rose by 10%, but
the inflation rate was 4% then real GDP would be 6%. This is because the inflation rate
offsets the raise in incomes that occur as a result of an increase in GDP.
Nominal GDP:
Nominal GDP is calculated based on the value of the goods and services produced as
collected, so it reflects not just the value of output but also the change in the aggregate
pricing of that output.
In other words, in an economy with a 5% annual inflation rate nominal GDP will increase
5% annually as a result of the growth in prices even if the quantity and quality of the
goods and services produced stay the same.
Real GDP:
Real GDP is the value of a country's total output of goods and services adjusted for
inflation or deflation. It allows economists, policymakers, and analysts to assess the
underlying growth of an economy without the distortion caused by changes in prices.
Real GDP is calculated by gathering data on the quantities of various goods and
services produced in the economy (quantities are often called "real" quantities). Then,
base-year prices are assigned to these quantities. The quantities produced are
multiplied by their base-year prices, and the products are summed for all goods and
services to get the real GDP for each year.
GDP Growth Rate:
The GDP growth rate compares the year-over-year (or quarterly) change in a country’s
economic output to measure how fast an economy is growing. Usually expressed as a
percentage rate.
If GDP growth rates accelerate, it may be a signal that the economy is overheating and
the central bank may seek to raise interest rates. Conversely, central banks see a
shrinking (or negative) GDP growth rate (i.e., a recession) as a signal that rates should
be lowered and that stimulus may be necessary.
GDP Per Capita:
GDP per capita is a measurement of the GDP per person in a country’s population. It
indicates that the amount of output or income per person in an economy can indicate
average productivity or average living standards. GDP per capita can be stated in
nominal, real (inflation-adjusted), or purchasing power parity (PPP) terms.

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GDP per capita = Real GDP/Population
Value of GDP:
It is the total monetary or market value of all the finished goods and services produced
within a country's borders in a specific time period.
Volume of GDP:
The volume of GDP is the sum of value added, measured at constant prices, by
households, government, and industries operating in the economy.
Positive economic growth rates:
A positive economic growth rate signifies that the economy has expanded during the
measured period.
This often means the country had increased economic activity and output. This growth
often leads to higher employment rates, improved living standards, and greater
opportunities for businesses and individuals.

Negative economic growth rates:

Negative growth is a contraction in business sales or earnings. It is also used to refer to
a contraction in a country's economy, which is reflected in a decrease in its gross
domestic product (GDP) during any quarter of a given year.
Negative growth is typically expressed as a negative percentage rate.
Total GDP:
Total GDP is the total value of goods/services within an economy in a year.

Other national income measures:

Gross National Income (GNI):
Gross National Income (GNI) can be worked out by taking the GDP figure and adding it
to the income paid into the country by other countries for such things as interest and
dividends.
This is in contrast to GDP which doesn’t include net income received from abroad. GNI
is similar to GNP, but is calculates income rather than output. For countries with a large
foreign population, the GNI figure can be much lower than GDP as some of the income
received by foreigners is sent back to their home countries. This can be seen in Ireland,
where lots of MNC’s locate due to their low corporation tax rate.
Gross National product (GNP):

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GNP includes the value of goods/services produced by citizens regardless of their
location. This means that the output of citizens working abroad is included in the sum
(even those that don’t send back their income as a remittance). However, GNI excludes
the output from foreign worker located in the domestic country (even if they don’t send
that income back to their home country). Therefore GNI = The final value of all goods
and services produced by domestic residents (GDP) plus income that residents have
received from abroad, minus income claimed by non-residents.
Comparison of rates of growth between countries and over time:
Comparing two countries GDP data may be less valuable information than comparing
the GDP per capita of two countries. This is because it allows for an easier comparison
due to the fact that it takes into account population differences.
Furthermore, using real data rather than nominal data can also make for a better/fairer
comparison. This is because a country that has a high inflation rate is likely to have a
higher GDP growth rate as it has been artificially boosted by the large increase in
inflation. Therefore, although consumer’s real incomes have not actually risen by much
in real terms, the nominal GDP growth rate may wrongly suggest otherwise. It is
important that this level of analysis is used when comparing countries economic data as
it has to be highly accurate in order to determine the level of success that a country’s
policy decisions have resulted in.
Purchasing Power Parities (PPPs) and the use of PPP-adjusted figures in
international comparisons:
What Is Purchasing Power Parity?
Purchasing power parity (PPP) is a popular macroeconomic analysis metric used to
compare economic productivity and standards of living between countries.
PPP involves an economic theory that compares different countries' currencies through
a "basket of goods" approach. That is, PPP is the exchange rate at which one nation's
currency would be converted into another to purchase the same and same amounts of a
large group of products.
Purchasing power parity helps to compare the costs of living between countries. For
example, if the basket of goods in the UK is the equivalent of $400 (after pounds have
been converted to dollars), but the basket of goods in America is worth $800, then the
purchasing power parity is 1:2. Therefore, although America may have a higher GDP
per capita than the UK, American citizens will be worse off. This is because they have a
higher cost of living, meaning their wages can buy fewer items than in the UK.
If GDP per capita in the UK was equivalent to $80,000 and GDP per capita in the US
was $100,000, then UK GDP (PPP) would be $80,000 and US GDP (PPP) would be
$50,000. Therefore, despite GDP per capita being higher in America, when adjusted to
purchasing power parity, the UK actually have a higher GDP per capita rate than

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America, suggesting a higher standard of living in the UK. This shows how PPP can be
used to give a more accurate comparison of different countries GDP rates

The limitations of using GDP to compare living standards between

countries and over time:
GDP does not take into account the improving quality of goods:
GDP does not take into account improvements in the quality and diversity of goods, as it
counts their final value only. For example, a phone 10 years ago has fewer functions
than a phone for the same price presently. However, because the values are the same,
the contribution to GDP would have been the same. This can potentially mean that one
country’s GDP per capita figure can be the same as another country that is less
technologically advanced and has worse quality goods/services.
GDP does not include unofficial or unpaid/goodwill work:
Some workers may choose to do work for free and therefore earn no income from that
work. Therefore, the value of the work produced is not included in the GDP figure. This
can be a big issue in LDC’s where there are high levels of subsistence agriculture. As a
result, the GDP figure stated is often underestimated.
Increases in real GDP may not be shared equally among an economy’s population:
Although a high GDP per capita suggests high levels of income amongst citizens, it
doesn’t show how that income is distributed amongst its population. For example, a
small percentage of the population may have a huge amount of income whilst the
majority of the population has a very low income. Those on very high incomes will boost
the GDP per capita figure, pushing up the average income figure. This masks the high
levels of inequality that may exist within society and therefore does not reflect the true
standards of living. Therefore, although two countries may have a similar GDP per
capita, the distribution of the income in those two countries may be very different from
each other.
GDP doesn’t take into account other factors that affect living standards:
A large increase in GDP growth is an indication of large increases in output and
therefore incomes also. However, this can result in negative impacts e.g. pollution,
congestion, number of hours worked and stress levels on people’s standard of living,
which is in contrast to what some people may associate with a high GDP growth rate.

National happiness:
UK national well-being The Office for National Statistics is trying to develop more ways
of measuring national well-being. It should give a wider picture of society and the
standard of living within the UK. In the UK in 2012, 91% of people were satisfied with
their family life. Those in Iceland were the most satisfied in the world, where 95% were
happy. Greece has the lowest life satisfaction rating of the OECD countries, as of 2015.

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The relationship between real incomes and subjective happiness The UK economy
grew by 5% in GDP per capita between 2007 and 2014, but showed no change in life
satisfaction. However, generally, the higher the GDP per capita, the higher the average
life satisfaction score.

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