Economic Growth Rate
Refers to a percentage change in the number and quality of commodities and services produced in an economy during a period.
What Is an Economic Growth Rate?
Economic growth rate refers to a percentage change in the number and quality of commodities and services produced in an economy during a period and is usually looked at regarding output or gross domestic production (GDP). While economic growth is simple, measuring it is highly challenging.
Growth is sometimes quantified as a rise in average earnings or inflation-adjusted GDP, but this is not the definition. Likewise, life expectancy is a metric of population health but not the concept of population health.
An economic growth rate reflects the change in the country's GDP compared to a previous time. These changes are expressed as percentages and indicate a country's economic health and growth potential.
A rise in economic growth rate typically regards as good, but if an economy experiences negative growth rates for two consecutive quarters, the country is technically in a recession.
To sum up, if an economy declines by 2% from the preceding year, the whole population's income falls by 2% during that year.
Economic development is typically separated from economic growth, which refers to economies near subsistence level, unlike the latter phrase that applies to economies with growing per capita incomes.
Key Takeaways
- Gross Domestic Product (GDP) measures the worth of a country's commodities and services.
- According to research, the size of the economy impacts GDP growth. The relationship between GDP growth and GDP across nations at a given period is convex. Growth accelerates until GDP hits its peak, which following that, it begins to fall.
- Expansion is a period of the economic cycle in which the economy is wealthy and prosperous, resulting in a graphical upward trend.
- During a recession, when more individuals are out of work or have their wages reduced, less money is invested in the economy, which can worsen the recession.
Calculating Economic Growth Rate
When it comes to economic growth, people frequently talk over one another. This is usually due to what economic growth is entangled with in terms of the way it is measured.
While it is simple to explain what growth is, quantifying "growth" is extremely complicated. In the worst circumstances, growth metrics are confused with growth definitions. Growth is frequently assessed in terms of earnings or inflation-adjusted GDP per capita.
However, these metrics do not constitute the definition of it, similar to having the average lifespan as an indicator of public health but not the concept itself.
GDP is the total worth of all products and services generated in our economy. The word "real" signifies that the sum has been adjusted to account for the impacts of inflation.
Economic Growth Rate = [Real GDP (Current Year) - Real GDP (Previous Year)/ Real GDP (Previous Year)] * 100
There are at least three approaches to calculating real GDP: the income approach, the expenditure approach, and the production approach. It is critical to understand which is currently utilized and the distinctions between them.
1. Income Approach
The income approach to calculating GDP is based on the reality that all expenses must match the total income yielded from producing all products and services in the economy.
It also presupposes that in an economy, there are four primary factors of production (land, labor, capital, and entrepreneurship) and that all income must flow to one of these sources.
Consequently, by combining all sources of revenue, we can calculate the entire output value of the economic activity during a time. Taxes, depreciation, and foreign-factor payments must then be adjusted.
Gross Domestic Product (GDP) = Total National Income + Sales Taxes + Net Foreign Factor Income + Depreciation
Where:
- Total National Income: The summation of wages, rent, interest, income, and profits
- Sales Taxes: Taxes imposed by the government on the sales of goods and services
- Depreciation: The decrease in the value of an asset because of its usage in a given period
- Net Foreign Factor Income: The difference between total revenue generated by citizens and businesses outside their country and total income generated by foreigners and businesses within the domestic country
2. Expenditure Approach
The expenditure technique for calculating GDP considers the total value of all final products and services consumed in an economy over a certain period.
This covers all consumer, government, and industry investment spending, as well as net exports. Because they employ the same calculation, the final GDP is equivalent to aggregate demand.
GDP = C + I + G + (X-M)
Where,
- C: Consumer Expenditure; for example, food, clothes, gas, etc
- I: Investment Expenditure; for example, purchasing land, machinery, etc
- G: Government Expenditure
- Net Exports (X-M): Exports minus Imports
3. Production or Value Added Approach
The name is self-explanatory and explains that a certain value is gained during production. It is also referred to as the expenditure approach in reverse.
In this approach, the cost of intermediate goods used to produce final goods is deducted when estimating the gross value-added total cost of economic output.
GDP = Gross Value of Output – Value of Intermediate Consumption
Where,
Intermediate consumption: goods and services consumed in the production process of final goods.
Factors That Contribute to Economic Growth
The economy can only expand by increasing the number and quality of the production components, which are broken down into four main groups: land, labor, capital, and entrepreneurship.
However, other variables can also influence economic growth, such as technology.
In an economy, factors of production are the resources utilized to develop or manufacture a product or service, and they are considered the foundations of an economy.
Natural resources, labor, money, entrepreneurship, and technological advancements are production components that directly link to generating economic progress.
As a result, this helps improve economic growth by enhancing the standard of living by cutting manufacturing costs and increasing earnings.
1. Natural resources
More natural resources, such as oil or mineral reserves, might spur economic growth by reshaping or expanding the nation's production possibility curve. Land, water, forests, and natural gas are other resources.
Realistically increasing a country's natural resources is challenging, if not impossible. Therefore, countries must guarantee that demand and supply are regulated to avoid the depletion of rare natural resources.
2. Capital
Although most people associate capital with cash, the term refers to several different things. Aside from manufacturing facilities, machinery, tools, and other equipment needed in the production process, capital products are also considered capital.
A fleet of trucks or forklifts, as well as heavy gear, are examples of capital. When the economy is prospering and expanding, firms may obtain cash to spend and invest while continuing to earn.
However, they must reduce spending to protect capital during the economic recession to maintain profitability. All of this is required to guarantee that they can continue to provide new products and services to the market.
3. Labor
One of the most crucial factors in a country's economic progress is labor. The availability and quality of labor may have a direct influence on the growth of an economy.
The quality of labor can be defined by their talents, inventiveness, training, and education.
A country's production will be the high quality of its well-trained and skilled labor force. A labor shortage slows economic growth, but a labor surplus, on the other hand, has less influence.
Therefore to achieve economic growth, a nation's human resources must be present in adequate numbers and granted the required knowledge, skills, and capabilities.
4. Technology
Technology is considered one of the essential variables influencing economic growth. It is defined by the use of scientific methodologies and production procedures.
Technological progress helps to boost productivity when working with restricted resources. Countries that have invested in technological advancement expand faster than those that have not.
The proper technology selection is equally critical for the success of an economy. Conversely, using the wrong technology results in expensive production.
5. Entrepreneurship
Entrepreneurship, according to economists, is among the most important components of the manufacturing process. Entrepreneurs combine all the other manufacturing variables to develop, create, and manufacture the product or service.
Entrepreneurs' success is dependent on the creation of a business strategy. After developing a company strategy, entrepreneurs should hunt for resources, hire employees, and obtain finance.
Why does Economic Growth Matter?
Real GDP growth, or the value of national output, income, and spending, is a measure of economic growth.
Economic growth essentially results in better living standards - higher real wages and the opportunity to dedicate more resources to other sectors like health care and education.
1. Increased Earnings
As a result of economic expansion, consumers may purchase more products and services, and their standard of living will rise. Economic growth during the twentieth century was a key influence in reducing absolute poverty and increasing life expectancy.
2. Reduced Unemployment
Higher economic growth will result in increased output from firms, which will boost the need for labor. As a result, unemployment will fall, resulting in less government expenditure on benefits and fewer social problems.
If the economy is in a downturn, accelerating economic growth will be a vital step toward reducing unemployment.
3. More funds for environmental protection
With increased economic growth, a society may spend more resources to encourage recycling and the utilization of renewable resources.
According to the Kuznets curve, economic expansion initially hurts the environment, but after a certain degree of growth, environmental damages caused to begin to decrease. This theory is divisive. But there is a chance that greater expansion will result in better environmental consequences.
4. Standard of living
People's living standards will rise as the economy grows. Economic growth can assist in reducing poverty by raising people's income and allowing them to buy necessities.
People with a lot of money may afford to buy more luxury things, which increases aggregate demand. This stimulates enterprises to generate more, raising the potential output level of the economy.
Even if tax rates don't change, taxes are collected more as income and output go up. As a result, the government may increase its spending on public services like education and health care, raising people's living standards.
5. Better Public Services
Increased economic growth leads to higher tax revenues, enabling the government to allocate more to public services like health and education, among many other things.
As a result, enhanced living standards, such as longer life expectancy, improved literacy rates, and a clearer understanding of societal and political concerns, may be feasible.
Economic Expansion
Economic expansion is the stage of an economic cycle where GDP has increased for two or more quarters and progressed from a depression to a peak. Consumers' increased employment, stable equity markets, and confidence in the economy define this period.
The economy is known to be booming during an expansion. Low-interest rates, where money is inexpensive to borrow, strong economic activity, and substantial discretionary expenditure are all characteristics of a thriving economy.
From a macroeconomic standpoint, GDP grows, disposable income per capita increases, and unemployment rates fall due to several employment opportunities.
The climax of growth marks the occurrence of a peak. When there is a high demand for things, inflation and prices rise. As a result, consumers gradually buy less, and macroeconomic indices stop increasing.
After peaking, economic growth tends to slow and decrease. This is because companies are not obtaining as much money to sustain or grow operations due to a shortage of cash circulating across the economy due to higher commodity prices.
Business owners frequently halt hiring and begin to lay off workers to decrease expenditures and shield themselves from balance-sheet danger, representing a time of contraction in the business cycle.
Key indicators such as weekly average hours worked by full-time employees, unemployment figures, retail sales for consumer products, and construction permits provide insight into whether the economy will expand or decrease shortly.
However, economists and analysts usually agree that the two major elements that best affect corporate earnings and the status of the overall economy are capital expenditure (the money corporations spend on maintaining, developing, and purchasing new assets) and interest rates.
What is an Economic Contraction?
Throughout history, many economic recessions have occurred and harmed the finances of people and companies in all sectors of society. All levels of the government take measures to avert economic downturns; nevertheless, they are not always effective.
But, since recessions have occurred several times previously, why is there a persistent chance that they may happen again? What gives rise to them? What impact do they have?
An economy similar to a wave in the water passes through cycles of highs and lows: it increases, its crest reaches a height, drops, and then begins to climb again.
When the economy grows, it is referred to as "economic growth," but when it contracts, it is referred to as "economic contraction" (or "downturn").
When the economy contracts for two successive quarters, it is considered to be in a recession and is generally determined by a measure known as "gross domestic product" (GDP). But people frequently mix the terms "recession" and "slow down."
In a recession, growth indicators are negative (the wave is falling). Still, in a slowdown, growth indications are positive (the wave is rising), although at a slightly slower pace than in the preceding quarter.
Each recession has its own set of causes and consequences. For example, companies tend to boost output to fulfill customer demand during an economic boom.
When demand peaks and begins to drop, an oversupply of products and services can cause a recession. Wars and pandemics can disrupt consumer patterns in the short, medium, and long term.
The Great Depression, which ran from 1929 to 1939, was the most severe and long-lasting depression in modern American history.
More recently, the early 1980s saw substantial contraction when the Federal Reserve hiked interest rates to tackle inflation. However, this contractionary period was temporary and followed by a powerful and prolonged period of expansion.
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