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Economic Growth | How is it calculated? Simple Methods for Calculation

Economic growth

Economic Growth | How is it calculated?

What is Economic Growth?

Economic growth is a process of changing the economic conditions of a country on an ongoing basis from the goods and services produced by an economy from time to time.

How is economic growth measured

Economic growth has two aspects:

Economic growth takes place over time and is a mostly irreversible process. It can be measured and is accompanied by phenomena of economic and social transformation. It is also accompanied by a questioning of society ‘s operating rules .

Structures are the set of relationships and proportions that define a given economic situation.

How is economic growth calculated?

Most countries use the GDP indicator to estimate their economic growth. You should know that the GDP corresponds to the value of all the goods and services that a country has produced throughout a year. Growth is measured by the estimate of GDP per capita. Some countries also use gross national product (GNP) as an indicator of economic growth. GNP is defined as the total value of goods and services produced by companies or persons having the nationality of the country, whether they benefit from an establishment in the country or abroad.

Economy growth formula using ECONOMIC GROWTH RATE (EG)

Economic Growth Rate (EG) is typically calculated using the following formula:

EG = [ (GDPold) / GDPold ] x 100%

Where:

This formula measures the percentage change in GDP from one period to another, indicating the rate of economic growth or contraction. It’s a fundamental metric for assessing a country’s economic performance.

Example calculation using economic growth rate (EG)

let’s go through a couple of examples using the Economic Growth formula:

Example 1:

Suppose a country’s GDP in 2020 (old) was $10 trillion, and in 2021 (new), it increased to $11 trillion.

Using the formula:

EG = [ (GDPold) / GDPold ] x 100%

EG≈0.10×100%=10%.

So, in this case, the economic growth rate is 10%.

Example 2:

Let’s consider another scenario where a country’s GDP in 2019 (old) was $8.5 trillion, and in 2020 (new), it decreased to $8 trillion.

Using the same formula:

EG = [ (GDPold) / GDPold ] x 100%

EG≈−0.059×100%≈−5.9%.

In this case, the negative value indicates a contraction in the economy, with an economic growth rate of approximately -5.9%.

These examples demonstrate how the economic growth formula is used to calculate the percentage change in GDP between different periods, providing insights into a country’s economic performance.

Economy growth formula using GDP

Economic growth is typically calculated using the Gross Domestic Product (GDP) formula, which measures the total value of all goods and services produced within a country’s borders over a specific period of time.

The formula for GDP is:

Where:

This formula provides a comprehensive overview of a country’s economic performance and growth.

Example calculations

Let’s consider a hypothetical scenario to illustrate how the GDP formula works:

Suppose we have a country called “Prospera” with the following data for a specific year:

Using the GDP formula:

=$1 trillion+$500 billion+$700 billion+($400 billion−$300 billion)

=$2.3 trillion

So, in this hypothetical scenario, Prospera’s GDP for that year would be $2.3 trillion. This indicates the total value of all goods and services produced within the country’s borders during that period.

Example 2

Let’s consider another hypothetical scenario for the country “Econland” with the following data:

Using the GDP formula:

=$800 billion+$300 billion+$600 billion+($200 billion−$150 billion)

=$1.75 trillion

In this hypothetical scenario, Econland’s GDP for that year would be $1.75 trillion. This represents the total value of all goods and services produced within Econland’s borders during that specific period.

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What are the effects of economic growth?

Strong economic growth will have a positive impact in many areas:

  1. Increased Purchasing Power: When an economy experiences growth, people generally have higher incomes and more disposable income. This means they can afford to buy more goods and services, which, in turn, boosts demand in the economy.
  2. Improvement of the Standard of Living: Economic growth is often associated with an improvement in the standard of living for the population. This includes better access to education, healthcare, housing, and other essential services. It also means people can afford higher quality goods and services.
  3. Increased Life Expectancy: Economic growth is linked to better healthcare infrastructure, access to quality healthcare services, and improved living conditions. As a result, life expectancy tends to increase in economically growing countries.
  4. Drop in Unemployment: A growing economy tends to create more jobs. As businesses expand and new ones emerge, they require additional labor. This leads to a decrease in the unemployment rate, as more people find employment opportunities.
  5. Decrease in the Poverty Rate: Economic growth has the potential to lift people out of poverty. When the overall economic pie is growing, it becomes possible to implement policies and programs that target poverty alleviation.
  6. Political Stabilization: A stable and growing economy can contribute to political stability. When people see improvements in their living conditions and economic prospects, they are generally less inclined to engage in political unrest or upheaval.
  7. Investment Opportunities: A growing economy tends to attract more investment. Both domestic and foreign investors are more likely to put their money into an economy that is expanding, as it offers a higher potential for returns.
  8. Technological Advancement: Economic growth often leads to increased research and development activities. This, in turn, fosters technological innovation and progress, which can have far-reaching benefits for society.
  9. Improved Infrastructure: Growing economies often invest in infrastructure projects such as roads, bridges, airports, and public transportation systems. This not only improves connectivity but also boosts economic efficiency.
  10. Positive International Relations: Countries with strong and growing economies tend to have more influence on the global stage. They are in a better position to negotiate trade deals, form strategic alliances, and contribute to international development efforts.

It’s important to note that while economic growth brings about many positive effects, it’s also crucial to manage it sustainably and ensure that benefits are distributed equitably across society. Additionally, growth should be balanced with environmental considerations to avoid negative impacts on the planet.

The limits of the measurement

Measuring economic growth using GDP as an indicator involves certain problems:

Limits to GDP itself

An increase in GDP does not necessarily imply an increase in output, and in fact there have been cases where GDP has increased but not output. This is due to facts such as undeclared production, especially when GDP is calculated by adding wages, gross operating surpluses and VAT . Thus, GDP is an indicator sensitive to extra-economic phenomena.

GDP assessment problems

Any indicator depends on an assessment, which is done through the price system. But, in certain cases, the prices can move away from the real cost of production. In addition, the valuation of the price system is done through reports sent to companies , which must fill them in with the requested data. When companies don’t know this data, make mistakes when copying it, or simply don’t return the reports, these errors affect the GDP assessment. So, it is an inherently unreliable indicator.

Limits of GDP per capita

GDP per capita can count as positive what is actually negative. For example, an AIDS epidemic that killed half of a country’s population but boosted drug production and doctors’ working hours would cause an increase in GDP per capita.

Externalities

Externalities are related to the previous point. These are consequences of economic activity that the market does not take into account. For example, a flu vaccination campaign indirectly increases GDP because more people will be able to work instead of staying home sick, but it is not possible to estimate precisely how much GDP has increased because of this. On the other hand, phenomena such as the precariousness of work or the deterioration of the environment are also effects of some types of economic activity that reduce the wealth of a country, but which are not taken into account by the GDP.
Finding an effective way to measure these externalities would be a very desirable reform in economics.

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What are the consequences of zero growth?

Zero growth means that the level of wealth created is equivalent to that of the previous year. If, as is the case in France, the population increases from one year to the next, this means that GDP per capita is decreasing. Indeed, more than the growth of a country, what counts the most to evaluate the evolution of the standard of living is the growth per inhabitant, that is to say in relation to the evolution of the population.

A lack of growth has negative consequences on public finances: tax revenues do not increase, the State has more difficulty reducing its public deficit and repaying its public debt, except by drastically reducing public spending.

Similarly, this has negative consequences on unemployment, on the ability of borrowers to repay their loans, etc.

Some voices are raised against this unbridled search for growth, highlighting the ecological, demographic and social dangers of this single objective. Some economists even advocate “degrowth” (i.e. a drop in GDP) to improve the lot of people and the planet.

Indeed, an increase in production leads to an increase in the consumption of raw materials, the emission of greenhouse gases and the generation of waste. Moreover, as fossil fuels are available in limited quantities, growth would in any case be destined to stop in the more or less short term.

These criticisms of the quest for ever higher growth are not unfounded. However, many economists point out that technological evolution makes it possible to produce more while limiting the environmental impact. We can also see that, throughout history, technological progress has made it possible to evolve from wood to coal, then from coal to oil and, perhaps in the future, to another source of energy.

Finally, the economy is becoming more service-oriented, in practically all countries. This means that production is shifting from agriculture and industry to services. Today, about three quarters of French GDP are represented by services, most of which are not or only slightly polluting (education, health, personal assistance, culture, security, advice, etc.).

If the production and consumption of services increase, then the GDP also increases (which means economic growth), without there being any significant ecological impact.


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Sources: Consultant4Companies, CleverlySmartPinterPandai, Science DailyTrading EconomicsInvestopediaWorld Bank

Photo credit: Pixabay

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