Economic Growth (Edexcel A Level Economics A)

Economic Growth

Gross Domestic Product (GDP)

• National income accounting measures the economic activity within a country and provides insights into how a country is performing

• One of the main methods to determine economic activity is to measure the rate of change of output in an economy

• The output of an economy is called gross domestic product (GDP)

• GDP is the value of all goods/services produced in an economy in a one-year period

• It can be measured using the following approaches

  • The expenditure approach: adds up the value of all the expenditure in the economy

    • This includes consumption, government spending, investment by firms and net exports (exports - imports)

  • The income approach: adds up the rewards for the factors of production used

    • Wages from labour, rent from land, interest from capital and profit from entrepreneurship

• Both approaches should provide the same figure as one party's expenditure is another party's income

• The value of GDP is different to the volume of GDP

  • The value is the monetary worth

  • The volume is the physical number

The distinction between real, nominal and per capita GDP

• In economics, the use of the word nominal refers to the fact that the metric has not been adjusted for inflation

• Nominal GDP is the actual value of all goods/services produced in an economy in a one-year period

  • There has been no adjustment to the amount based on the increase in general price levels (inflation)

• Real GDP is the value of all goods/services produced in an economy in a one-year period - and adjusted for inflation

  • For example, if nominal GDP is £100bn and inflation is 10% then real GDP is £90bn

• GDP per capita = GDP / the population

  • It shows the mean wealth of each citizen in a country

  • This makes it easier to compare standards of living between countries: 

    • For example, Switzerland has a much higher GDP/capita than Burundi 

Gross National Income

• GDP may not be the best metric to measure a country's output or wealth

• GDP measures the value of production within a country's borders

  • It does not consider the income earned by its citizens while operating outside of the country

• Gross national income (GNI) measures the income earned by citizens operating outside of the country + the GDP

  • Many citizens employ their resources outside of a country's borders and then send the income home

• Gross national product (GNP) takes it one step further

  • GDP + income from abroad - income sent by non-residents to their home countries

• GNP/capita provides a much more realistic view of a country's wealth than GDP/capita

Growth Comparisons Between Countries

• National income statistics are useful for making comparisons between countries

  • They provide insights on the effectiveness of government policies

  • They allow judgements to be made about the relative wealth and standard of living within each country

  • They allow comparisons to be made over the same or different time periods

    • For example, the growth of the Asian Economies in the last 15 years can be compared to the growth of the European Economies in the 1990s

• Using real GDP is a better comparison than nominal GDP

  • One country may have a much higher rate of economic growth but also a much higher rate of inflation. Real GDP provides a better comparison

• Using real GDP/capita provides better information than real GDP as it takes population differences into account

• Using real GNI/capita is a more realistic metric for analysing the income available per person than GDP/capita

• Using real GNP/capita provides information on the income that is actually within a country's borders

  • This value can be significantly different from GDP/capita

Purchasing Power Parities (PPP)

• Purchasing power parity (PPP) is a conversion factor that can be applied to GDP, GNI and GNP

• It calculates the relative purchasing power of different currencies

  • It shows the number of units of a country's currency that are required to buy the same baskets of products in the local economy, as $1 would buy of the same products in the USA or another country 

• The aim of PPP is to help make a more accurate standard of living comparison between countries where goods and services cost different amounts

• If a basket of goods cost $150 in Vietnam (once the currency has been converted) and the same basket of goods cost $450 in the USA, the purchasing power parity would be 1:3

  • It seems like the cost of living is much higher in the USA

  • However, if the USA GNP/capita is more than three times higher than the GNP/capita of Vietnam, it could be argued the USA has better standards of living

  • Conversely, if the GNP/capita in the USA was less than three times that of Vietnam, it could be argued that Vietnamese citizens enjoy a higher standard of living as they spend less income to acquire the same goods and services

Limitations of Using GDP for Comparisons

A Table Which Explains the Limitations of Using GDP Data To Compare Living Standards Between Countries and Over Time

National Happiness

• National happiness and societal well-being are measured in the UK by the Office for National Statistics (ONS)

• While GDP focuses on production, happiness focuses on health, relationships, the environment, education, satisfaction at work and living conditions

• National incomes statistics tend to present more positive data, while national happiness surveys yield more normative data

• There is a link between income and happiness and the Easterlin Paradox is often used to explain it

  • Happiness and increases in income have a direct relationship up to a point

  • Beyond that point, the relationship is less evident