Question

What is economic growth and how do we use GDP to measure an economy

Answer 1

Economic growth

Economic growth is an increase in the production of economic goods and services, compared from one period of time to another. It can be measured in nominal or real (adjusted for inflation) terms. Traditionally, aggregate economic growth is measured in terms of gross national product (GNP) or gross domestic product (GDP), although alternative metrics are sometimes used.

Economic growth is commonly measured in terms of the increase in aggregated market value of additional goods and services produced, using estimates such as GDP.

Growth is usually calculated in real terms - i.e., inflation-adjusted terms – to eliminate the distorting effect of inflation on the prices of goods produced. Measurement of economic growth uses national income accounting. Since economic growth is measured as the annual percent change of gross domestic product (GDP), it has all the advantages and drawbacks of that measure. The economic growth-rates of countries are commonly compare using the ratio of the GDP to population.

The "rate of economic growth" refers to the geometric annual rate of growth in GDP between the first and the last year over a period of time. This growth rate represents the trend in the average level of GDP over the period, and ignores any fluctuations in the GDP around this trend.

Economists refer to an increase in economic growth caused by more efficient use of inputs (increased productivity of labor, of physical capital, of energy or of materials) as intensive growth. In contrast, GDP growth caused only by increases in the amount of inputs available for use (increased population, for example, or new territory) counts as extensive growth.

Development of new goods and services also generates economic growth.As it so happens, in the U.S. about 60% of consumer spending in 2013 went on goods and services that did not exist in 1869.

Example of economic growth

• If the Central Bank cut interest rates, this would provide an incentive for firms to invest (borrowing would now be cheaper).
• This investment is a component of AD and AD will rise. With higher investment, more people will be employed, and there is a purchase of raw materials.
• Also, the cut in interest rates will encourage consumer spending due to lower borrowing costs and lower mortgage repayments. This will cause an additional rise in AD.
• The investment will also lead to an increase in productive capacity (LRAS) with firms gaining more capacity to meet demand.

How do we use GDP to measure an economy

GDP is measured by taking the quantities of all goods and services produced, multiplying them by their prices, and summing the total. GDP can be measured either by the sum of what is purchased in the economy or by what is produced.

Gross domestic product (GDP) 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. As a broad measure of overall domestic production, it functions as a comprehensive scorecard of a given country’s economic health.

GDP do a reasonable job in capturing changes in economic wellbeing has one important exception. We argue that the exclusion of non-market activities that bear on economic well-being merits more attention, particularly given the potential for changes in the importance of such activities over time to change the degree to which changes in GDP capture changes in well-being. Moreover, there are several important areas where measurement falls short of the conceptual ideal. First, the national accounts may mismeasure the nominal GDP arising from the digital economy and the operation of multinationals corporations. Second, the deflators used to separate GDP into nominal GDP and real GDP may produce a biased measure of inflation. Our analysis suggests that, for goods and services that do not change in quality over time, current deflator methods work reasonably well. But, for new goods and services or goods in services that are changing in quality, current methods may not capture consumer surplus well. We believe that efforts to improve price measurement in order to measure consumer welfare should be pursued, as it is clear that such a measure would be very useful for understanding the current state of the economy and for policymaking.

(GDP) is one of the most widely used measures of an economy’s output or production. It is defined as the total value of goods and services produced within a country’s borders in a specific time period — monthly, quarterly or annually. GDP is an accurate indicator of the size of an economy and the GDP growth rate is probably the single best indicator of economic growth while GDP per capita has a close correlation with the trend in living standards over time.

GDP calculation:-

GDP can be calculated either through the expenditure approach (the sum total of what everyone in an economy spent over a particular period) or the income approach (the total of what everyone earned). Both should produce the same result. A third method, the value-added approach, is used to calculate GDP by industry.

Expenditure-based GDP produces both real (inflation-adjusted) and nominal values, while the calculation of income-based GDP is only carried out in nominal values. The expenditure approach is the more common one and is obtained by summing up total consumption, government spending, investment, and net exports.

GDP = C + I + G + (X – M)

where:

• C = private consumption or consumer spending;
• I = business spending;
• G = government spending;
• X = value of exports
• M = the value of imports.

As Nobel laureate Paul A. Samuelson and economist William Nordhaus put it:

"While GDP and the rest of the national income accounts may seem to be arcane concepts, they are truly among the great inventions of the twentieth century.”