Measuring Economic Growth

A-level Economics

What it is. How it's calculated. What it's used for.

One of the most important topics you will learn about in macroeconomics is economic growth. Economic growth is measured in the changes in GDP (Gross Domestic Product), more specifically, Real GDP (more about the differences later).  GDP is 'a measure of the total value of goods and services produced domestically within an economy'.  It’s basically summing up the value of everything we have made.

GDP is important because it shows us how much output the economy is producing, or how much income it is making (same thing really).  If GDP goes up, it means national income is going up so the economy is producing more than before.  It is important for the country in the same way that it is important for an individual to be making more money.  Making more money means you can buy more things and in general, it will lead to a better standard of living. 

When studying macroeconomics, it is very important for you to know the difference between Nominal (money) GDP, and Real GDP.  It is so important to know the difference between the two.  So I will provide an example for you below.  To make it easier to understand, I will use smaller numbers as GDP figures are usually in the billions and trillions!

Example (Nominal vs Real GDP): 

Imagine a country produces 10 goods in a year, the value of which are £50 each.  The economy would be producing an GDP income of £500 in that year.  In the second year, the price of these goods go up by £1 each.  So this year, the economy’s GDP income will be £510 (£51 x 10 goods).  So it looks like GDP has gone up, right?  But in reality it was just the price of the goods that went up.  The output of 10 goods stayed the same, so we’re not really growing as a country, are we?  We’re not actually producing any more. It was inflation that caused the nominal GDP to rise in this case.

This is pretty much how nominal GDP is calculated.  It is not a good measure for us to use when looking at historic GDP, because as we know, prices are always going up so we don’t know if we are actually producing more as a country.  If you look back at the 1960s, UK GDP was hovering around the $70 billion mark.  Today, it is in the trillions - about $2.5 trillion.  It’s about 40x bigger today but remember in the 1960s you could buy a house outright for £4000!

This is where Real GDP comes in.  Real GDP takes into account these changes in prices.  So if real GDP goes up, then it means the economy has produced more output.  Real GDP takes into account the effects of inflation.

GDP vs GDP per Capita

When we are comparing countries’ economies, the first thing we usually look at is GDP overall.  For example, currently China has a much bigger economy than the UK.  However, if you are interested in trying to figure out the living standards in a country, it is better to use GDP per Capita instead of GDP alone.  Why?  Because GDP per Capita is the same as GDP per head, or income per head.  It can be calculated by taking GDP and dividing by the population. 

If you do this, you can find some interesting numbers.  For example, China’s GDP is about $11.3 trillion, whereas the UK’s GDP is around $2.6 trillion in 2016.  So at first glance it looks like China is much richer than what the UK is.  However, people in the UK are more likely to have better living standards because China’s GDP has to be split across the population.  When you do this you find that China’s GDP per capita is only about $8000 (because they have over a billion people residing there), whereas the UK’s is around $42,000.  Average income per head is much higher in the UK.  

FACT:  Which country in the world has the highest GDP per Capita?  The answer is Luxembourg (as of 2015) with $101,450.  

[Source: http://data.worldbank.org/indicator/NY.GDP.PCAP.CD?year_high_desc=true]
 

GDP and living standards

Both GDP and GDP per capita are not such great figures to look at living standards, however,  Yes, GDP per Capita is a better measure than GDP, but there are other factors that determine the standard of living.  E.g. the level of technology, the level of government spending, life expectancy, the standard of education etc.  A better measure of living standards and development is the HDI (Human Development Index)  It takes into account average income per head, expected years of schooling and the death rate to better give us an idea of living standards in a country.

Another reason GDP or GDP per Capita is not a great measure is the fact that a country’s income is not fairly distributed.  We know that there are some people on the poverty line and at the same time there are many billionaires.  So GDP per Capita will tend to overestimate the general standard of living if income is unequal. 

So, in summary you should now know:

1. Definition of GDP

2. Difference between Nominal and Real GDP

3. Difference between GDP and GDP per Capita and when we use the two

4. GDP as an indicator of living standards

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