Economic Growth

This section explains economic growth covering, the rates of change of real Gross Domestic Product (GDP) as a measure of economic growth, other national income measures such as Gross National Income (GNI) and the comparisons of rates of growth between countries and over time.

Economic growth refers to an increase in the quantity of goods and services produced by an economy over time, usually measured by the annual change in Real Gross Domestic Product (GDP). Let’s break down the key concepts involved in understanding economic growth:

Rates of Change of Real Gross Domestic Product (GDP) as a Measure of Economic Growth

Real GDP is the value of all goods and services produced by an economy, adjusted for inflation. When we discuss economic growth, we're usually talking about the rate of change of real GDP, the percentage increase or decrease in the output of goods and services from one period to the next.

Formula for Economic Growth Rate:

$$\text{Economic Growth Rate} = \left( \frac{\text{Real GDP in Current Year} - \text{Real GDP in Previous Year}}{\text{Real GDP in Previous Year}} \right) \times 100$$

Interpretation: A positive growth rate indicates an expanding economy, whereas a negative growth rate signifies contraction (recession).

Distinction Between Key Economic Terms

Understanding the distinctions between various terms is crucial for interpreting economic data:

Real vs Nominal GDP

• Nominal GDP is the value of output produced in an economy, measured at current prices without adjusting for inflation.
• Real GDP accounts for inflation and reflects the true value of goods and services produced, allowing for a more accurate comparison over time.

Total vs Per Capita GDP

• Total GDP is the sum of the value of all goods and services produced in an economy.
• Per Capita GDP divides the total GDP by the population, giving a measure of average economic output per person, which is useful for comparing living standards between countries.

Value vs Volume

• Value refers to the monetary worth of goods and services produced (often linked with nominal GDP).
• Volume refers to the actual quantity of goods and services produced, regardless of their monetary value (related to real GDP).

Other National Income Measures: Gross National Income (GNI)

In addition to GDP, we also use Gross National Income (GNI) to measure economic performance. GNI adjusts GDP by adding income received from abroad and subtracting income paid to foreign residents.

GNI vs GDP:

• GNI includes income from foreign investments and remittances sent back to the country by nationals working abroad.
• GDP focuses solely on domestic production, regardless of who owns the productive assets.

Comparison of Rates of Growth Between Countries and Over Time

When comparing the rates of economic growth across different countries, it’s important to account for differences in population size, inflation, and currency values. Some key points to remember:

• Higher GDP Growth Rates: May indicate a rapidly growing economy, but can also reflect a country starting from a lower base (lower GDP in the previous year).
• Lower GDP Growth Rates: Often found in developed economies, where growth may be steady but slow due to already high levels of output.

To make meaningful comparisons, it's essential to adjust for factors like inflation, population growth, and currency fluctuations.

Understanding of Purchasing Power Parities (PPPs) and the Use of PPP-Adjusted Figures in International Comparisons

Purchasing Power Parities (PPPs) are a method used to compare the relative value of currencies by considering the cost of living and inflation rates in different countries. Rather than using exchange rates, PPPs adjust GDP for the differences in price levels between countries.

• PPP-Adjusted Figures:
  PPP-adjusted figures allow for more accurate comparisons of economic performance and living standards, as they reflect what a given amount of money can actually buy in different countries, rather than relying on fluctuating exchange rates.
• Example: If one country has a higher cost of living than another, using nominal exchange rates could mislead us into thinking the first country is wealthier. PPPs adjust for these differences.

The Limitations of Using GDP to Compare Living Standards Between Countries and Over Time

While GDP is an important indicator of economic output, it has several limitations when it comes to comparing living standards:

Distribution of Income: GDP measures total output but doesn't show how wealth is distributed. A high GDP could coexist with significant inequality.

Non-Market Transactions: GDP excludes activities like volunteer work or household labour, which can be important for wellbeing.

Environmental Factors: GDP does not account for environmental degradation or the depletion of natural resources, which could negatively impact long-term living standards.

Quality of Life: GDP does not measure the quality of life, such as health, education, and leisure, which are vital for assessing living standards.

National Happiness and Wellbeing

In the UK and elsewhere, there is growing interest in measuring national happiness and wellbeing as a complement to traditional economic indicators like GDP.

UK National Wellbeing:
The UK government has introduced measures of national wellbeing, focusing on areas such as life satisfaction, health, education, and the environment. These measures help to give a more holistic view of the country's progress.

The Relationship Between Real Incomes and Subjective Happiness:
Research suggests that real income is positively correlated with happiness, but the relationship is not linear. While higher incomes can improve quality of life, beyond a certain point, increases in income may have little impact on subjective wellbeing. Other factors, such as social connections, sense of purpose, and work-life balance, are also critical to overall happiness.

Summary

To effectively understand economic growth and performance, we need to consider a variety of measures, not just GDP. While GDP remains a cornerstone of economic analysis, using additional indicators like GNI, PPP-adjusted figures, and measures of wellbeing provides a more comprehensive picture of a country’s economic health and its citizens’ quality of life.

Key Points to Remember:

• Real GDP is the most common measure of economic growth.
• Always distinguish between real and nominal measures, and total vs per capita.
• GNI gives a broader picture of national income by including overseas earnings.
• PPPs are essential for accurate international comparisons.
• GDP has limitations, particularly in terms of comparing living standards and wellbeing.
• National happiness is influenced by many factors beyond income, such as health, relationships, and personal satisfaction.