Economic Growth and GDP - A-Level Economics
How is economic growth measured?
Economic Growth is an expansion in the productive capacity (potential output) of an economy, characterized by an outward shift of the PPF curve.
- Economic growth enables a society to produce more goods and services in any given period as a result of an expansion of its resources.
- The growth of an economy is judged upon the rate of growth of Real GDP (Gross Domestic Product).
- Recession occurs when there are two consecutive periods of negative economic growth.
Gross Domestic Product (GDP)
GDP is a measure of the economic activity in an economy. GDP is found by measuring the total value of all goods and services produced in an economy over a given period of time, usually a year.
The value of GDP is also equivalent to the sum of all incomes earned in a year and to the sum of all the expenditure in one country in a year. The government measures all three flows: goods, income and expenditure. These should all be equal because for everything that is earned, something must be spent and therefore something must be produced.
Therefore, GDP is the value of output or expenditure or income in an economy.
Actual Growth vs. Potential Growth
It is often difficult to judge whether an increase in GDP does mean economic growth. If you look at a PPF curve, a country might move from a position within the curve to a position closer to the curve or on the curve (maximum efficiency). This means that the country is working more efficiently and is therefore producing more, causing GDP to increase. However, this is not an increase in productive capacity, as the PPF curve does not shift outwards. Therefore, in theory, this is not economic growth. Actual Growth is an increase in real incomes (GDP). Potential Growth is an increase in the productive capacity of an economy, characterized by an outward shift of the PPF curve (and the shift of the AS curve to the right).
Actual Growth is an increase in real incomes (GDP).
Potential Growth is an increase in the productive capacity of an economy, characterized by an outward shift of the PPF curve (and the shift of the AS curve to the right).
What are the limitations of GDP as a measure of growth?
Economists often try to measure the standard of living of a country. This is dependent on the happiness of the people in the economy, and because this is difficult to measure, we look at the consumption and income within the economy-‐ GDP.
An increase in GDP tells us that a country is experiencing increasing incomes, output and spending. This seems to be a good thing because people can have more goods and services, implying that they have a better standard of living.
⇒ The inadequacy of GDP as a measure of standards of living
GDP can be a good indicator of the number of resources available to citizens of a country, however it does not necessarily tell us about the standard of living:
Nominal GDP takes no account of inflation
Inflation results in an increase in prices of goods, and therefore the value of goods produced (i.e. GDP) will increase. However, whilst the value of goods increases, the value of money decreases, so the spending power of a household’s income is eroded. Thus, there is no real benefit for citizens and standard of living does not improve, despite increases in GDP levels.
Total GDP takes no account of differences in population
Unless it is measured ‘per capita’, the GDP of India is higher than that of Andorra. Therefore, we might be led to believe the quality of life of people in India is better, which is untrue because Andorra has a much higher GDP per capita.
Defense and related expenditures
When the government invests in weapons and defense during war, standard of life usually does not improve but GDP increases.
GDP does not take into account the changing quality of goods and services
As time moves on, technology improves greatly. For example, a satellite TV might have cost £1000 in 2008, and a plasma screen TV might cost £1000 in 2010. Therefore, the value of the output will not increase, so GDP remains constant, but there is an improvement in the standard of living between 2008 and 2010 because in 2010 the quality of goods is much better.
GDP does not take into account income distribution
Real GDP per capita shows average income per person, but this ignores the possibility of there being a top-‐heavy economy (wealth is only possessed by a few rich people)
GDP does not take into account the informal sector
Developing economies tend to have a larger informal sector, and therefore their GDP suffers, implying that quality of life is worse.
Also, GDP does not take into account unofficial work such as caring for older family and cleaning homes.
GDP does not take into account other impacts on our standard of living
Other factors which affect standard of living include:
- Environment
- Public Health
- Crime Rate
- Working Conditions
For example, if an oil spill occurred near a beach, the landscape would be degraded and the beach ruined. However, money spent on cleaning the damage adds to the GDP, which implies that the oil spill has improved the standard of living which it most definitely has not!
GDP does not take into account leisure time
A society that works more hours will have a higher GDP but not necessarily more happiness.
Exchange Rates
See below
⇒ Problems of comparison between developed and developing countries.
GDP does not take into account income distribution
Developing countries are more top heavy (inequality), with a few businessmen earning a large share the country’s income, whilst most people are poor. This makes the quality of these developing life look better than it really is.
GDP does not account for the informal sector
GDP does not include services for which no tax is paid. For example, if a good is sold on the black market, it might not be declared because it could be illegal or because the sellers do not want to pay tax. This is a problem because the informal sector is larger in developing countries, making the quality of life look worse than it really is.
Also, countries with high amounts of rainforest appear worse off because subsistence farmers do not sell their goods but rather consume what they produce, meaning that the goods they produce are not registered in official figures.
Total GDP does not account for population
Therefore GDP of larger countries is greater, unless GDP is measured ‘per capita’.
Exchange Rates affect GDP
Income may be higher in one country, but the purchasing power of the income (i.e. what the money can buy you) is not always reflected in the exchange rate.
This is because many countries peg (fix) their interest rates. This makes investing in bonds and assets in the country more desirable. To invest in these, foreigners need more of the country’s currency. The increased demand for currency raises the exchange rate. Therefore, the currency of the country is now worth more, which means that for the amount produced, the value in dollars will be even higher. Therefore, the exchange rate reflects the government’s policy and actions rather than the relative purchasing power of incomes in these countries.
New exchange rates called Purchasing Power Parity (PPP) exchange rates are designed to reflect the relative purchasing power of incomes in different societies more accurately than real exchange rates. However, PPP is sometimes not enough because people in some countries have to purchase goods that people in other countries get free from the government. Also, PPP changes very quickly and is inaccurate.
GDP does not tell us about future growth patterns
Spending on investment goods might mean living standards will be better in the future, at the expense of living standards today. Therefore, it is better to look at what is actually being produced in an economy, rather than just the value of all the goods produced.
GDP does not account for quality issues
Spending on schools may be higher in one country as opposed to another, but this does not guarantee higher quality of education.
Additional Guidance Notes
Difference between Real and Nominal
Nominal values are values of an economic variable based on current prices, taking no account of changing prices through time (inflation)
Real values are values of an economic variable taking account of changing prices through time (they have been adjusted to remove the effect of inflation)
Nominal GDP is evaluated using current prices, whilst Real GDP is evaluated using a base price.
If the government expenditure on education is rising in real terms, we mean that the government expenditure on education is increasing at a greater rate than the rate of inflation.
| Year | Output | Price | Nominal | Real |
|---|---|---|---|---|
| 1 | 5 | 2 | 5 x 2 = 10 | 5 x 5 = 25 |
| 2 | 5 | 5* | 5 x 5 = 25 | 5 x 5 = 25 |
| 3 | 8 | 10 | 8 x 10 = 80 | 8 x 5 = 40 |
*Base Price (chosen by economists)
Difference between Total and ‘Per Capita’
We often measure the GDP per capita, which is the average level of GDP per person. This gives us an indication of the average income per head and allows us to compare countries with differing populations.
Difference between ‘Value’ and ‘Volume’
GDP is measured in value not volume of goods produced. For example, Germany is the biggest exporter in the world by value, whereas China exports much more in terms of volume of goods.
Index Numbers
Economists often use index numbers, which are numbers represented as a proportion of a base number, which is given the value of 100.For example, if we want to analyse the number of rainy days in the UK this year for the next three years, we could represent the data as index numbers, with the value for 2012 being the base number.
| Year | Number of Rainy Days | Index Number |
| 2012 (Base) | 50 | 100 |
| 2013 | 100 | 200 |
| 2014 | 75 | 150 |
The % change from 2013 to 2014 is not 150 / 200. It is (150/100) / (200/100) = 0.75 = 25% Fall
Economic growth is the increase in the production of goods and services in an economy over a specific period. It’s important because it is a key indicator of a country’s economic health and is linked to various factors such as job creation, poverty reduction, and standard of living.
There are two main types of economic growth: intensive growth and extensive growth. Intensive growth is achieved through improvements in efficiency, technology, and productivity, while extensive growth is achieved through increases in the quantity of inputs such as labor, capital, and natural resources.
The drivers of economic growth include factors such as investment, innovation, education and training, infrastructure development, and favorable government policies.
GDP per capita is the total GDP of a country divided by its population. It is calculated by dividing the total GDP by the number of people living in the country.
GDP is often used as a proxy for a country’s standard of living because it measures the amount of goods and services produced in a country. However, GDP per capita doesn’t take into account factors such as income distribution, access to healthcare, and education, which are also important determinants of the standard of living.
In general, economic growth tends to lead to lower unemployment rates as more jobs are created. However, the relationship between economic growth and unemployment is complex and can vary depending on the country’s economic structure, labor market policies, and other factors.
Governments can promote economic growth through a variety of policies such as investments in infrastructure, education and training programs, tax incentives for businesses, and trade policies that encourage exports.
GDP has several limitations as a measure of economic growth. For example, it doesn’t take into account non-monetary factors such as environmental degradation, income inequality, and the quality of life. Additionally, it only measures economic activity within a country’s borders and doesn’t account for international trade or financial flows.
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