Economic growth

A) Rates of change of real Gross Domestic Product (GDP) as a measure of economic growth

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.

B) Distinction between:

Real and nominal:

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.

Total and per capita

Total GDP is the total value of goods/services within an economy in a year. On the other hand, GDP per capita takes into account the difference in populations between countries. It does so by taking the GDP figure and dividing it by the country’s population. This gives the average output/income per person, making it easier to compare standards of living amongst different countries.

Value and volume

The value of goods/services shows what certain goods/services are worth. However, the volume shows the number of goods/services that are produced. This is very important to remember when talking about trade. Although a country may import more goods/services than they export, they could still record a trade surplus. This is because the value of exports may exceed the value of imports, despite the volumes not.

C) 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)

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.

D) Comparison of rates of growth between countries and over time

You should be able to use economic data to compare the economic performance between different countries and draw a conclusion about an individual country’s economic performance over a long time period. It is also important that you know the different assumptions made during the process. For example, 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.

E) Understanding of Purchasing Power Parities (PPPs) and the use of PPP-adjusted figures in international comparisons

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 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

F) 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 e.g. pollution, congestion, number of hours worked and stress levels – 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 on people’s standard of living, which is in contrast to what some people may associate with a high GDP growth rate.