What is Economic Growth and How to Measure it?

Introduction

 

Economic growth is the increase in the goods and services produced by an economy, typically a nation, over a long period of time. 

 

It is measured as a percentage increase in the real gross domestic product (GDP) which is the gross domestic product (GDP) adjusted for inflation. The market value of all final goods and services produced in a country or economy is referred to as GDP.

 

Economic historians have tried to come up with a theory of stages that each economy must go through as it develops. To explain the progression from one stage to the next, various theories have been proposed. 

 

The two most frequently mentioned factors are entrepreneurship and investment. While the definition of economic growth is simple, measuring it is extremely difficult. Income measures are just one way to look at how countries' economies differ and how their prosperity changes over time.

 

Price, quality, and currency differences complicate comparisons over time and across borders, as explained below. Economic prosperity and long-term economic growth are relatively recent achievements for humanity, according to long-term social history. (You can understand the long and short-term impact of economic growth by following the link.)

 

Measuring Economic Growth

 

Economists use a variety of methods to determine how quickly the economy is growing. Real gross domestic product, or real GDP, is the most common way to measure the economy. 

 

GDP is the total value of everything produced in our economy, including goods and services. The term "real" denotes that the total has been adjusted to account for inflationary effects.

 

Real GDP growth can be measured in at least three different ways. It's crucial to know which one is being used and what the differences are between them. The three most common methods for calculating real GDP are:

 

1. Income approach

 

The income earned from the production of goods and services is the starting point for the GDP income approach formula. We calculate the income earned by all the factors of production in an economy using the income approach method.

 

The inputs that go into making the final product or service are referred to as factors of production. Within a country's domestic boundaries, the factors of production for a business are Land, Labor, Capital, and Management.

 

Gross Domestic Product (GDP)=total national income + sales taxes, depreciation+net foreign factor income.

 

Where,

 

• Total National Income (TNI) is the sum of all wages, rents, interest, and profits in the country. 
• Sales taxes are levied by the government on purchases of goods and services.
• Depreciation is the amount that is attributed to an asset-based on how long it will be used.

 

Net foreign factor income is the difference between total income generated by citizens and companies outside their country of origin and total income generated by foreign citizens and companies within that country.

 

2. Expenditure approach

 

The second approach, known as the expenditure approach, is the polar opposite of the income approach, as it begins with money spent on goods and services rather than income. 

 

This metric measures the total amount spent on goods and services by all entities within a country's domestic borders. Let's take a look at how to calculate GDP using the expenditure method.

 

GDP (as measured by expenditure method) = C + I + G + (EX-IM)

 

Where,

 

• C: Consumer Expenditure, which refers to when people spend money on various goods and services. For example, food, gas, and a car.
• I: Investment Expenditure, which refers to when businesses spend money to invest in their operations. Purchasing land, machinery, and other items, for example. 
• G: Government Expenditure, which refers to how much money the government spends on various development projects. 
• Exports minus Imports, or Net Exports (EX-IM). i.e., we calculate GDP by including exports to other countries and subtracting imports from other countries into our country.

 

3. Output approach

 

The monetary or market value of all goods and services produced within a country's borders is calculated using the GDP Output Method. (source)

 

GDP at constant prices, or Real GDP, is calculated to avoid a distorted measure of GDP due to price level changes. GDP is calculated using the Output Approach using the following formula: 

 

Real GDP (GDP at constant prices) – Taxes + Subsidies = GDP (as per output method).

 

 

5 Economic Growth Factors

 

Only by increasing the quality and quantity of the factors of production, which are divided into four categories: land, labour, capital, and entrepreneurship, can the economy grow but there are other factors as well that affect the economic growth such as technology. 

 

Factors of production are the resources used to create or manufacture a good or service in an economy. The factors of production, or the resources used to create and produce a good or service, are the foundations of an economy.

 

Natural resources, labour, capital, entrepreneurship and technology are the factors of production that are seamlessly interwoven to create economic growth. By lowering production costs and rising wages, improved economic growth raises the standard of living.

 

• Natural resources

 

By shifting or increasing the country's Production Possibility Curve, more natural resources, such as oil or mineral deposits, could boost economic growth. Other resources include land, water, forests, and natural gas.

 

Realistically, increasing the number of natural resources in a country is difficult, if not impossible. To avoid the depletion of scarce natural resources, countries must ensure that supply and demand are balanced. Improved land management has the potential to improve land quality while also contributing to economic growth.

 

Saudi Arabia's economy, for example, has long been reliant on its oil reserves.

 

• Labor

 

One of the most important determinants of a country's economic growth. The quantity and quality of available labour can have a direct impact on an economy's growth.

 

Labor's quality is determined by its skills, creativity, training, and education. If a country's labour force is well-trained and skilled, the country's output will be of high quality.

 

A shortage of skilled labor, on the other hand, stifles economic growth, whereas a labour surplus has less impact. As a result, a country's human resources should be sufficient in number and equipped with the necessary skills and abilities in order to achieve economic growth.

 

• Capital

 

Capital goods include manufacturing plants, machinery, tools, and any other equipment used in the manufacturing process. A fleet of trucks or forklifts, as well as heavy machinery, are examples of capital.

 

Factory, machinery, and road capital will be better invested, lowering the cost of economic activity. Physical labour is less productive than better factories and machinery. This increased productivity has the potential to increase output. 

 

A strong highway system, for example, can reduce inefficiencies in moving raw materials or goods across the country, boosting GDP.

 

• Technology

 

One of the most important factors that influence an economy's growth. Technology entails the use of scientific methods and manufacturing techniques. To put it another way, technology is the nature and type of technical instruments used by a certain amount of labor.

 

Technological advancement aids in increasing productivity while working with limited resources. When comparing countries that have worked in the field of technological development to countries that have not, countries that have worked in the field of technological development grow faster. 

 

The right technology selection is also important for an economy's growth. Inappropriate technology, on the other hand, leads to high production costs.

 

• Entrepreneurship

 

The fourth factor is entrepreneurship, which includes the visionaries and innovators who drive the entire manufacturing process. To conceptualize, create, and produce the product or service, the entrepreneurs combine all of the other factors of production. They are the driving forces behind any technical change in the economy that has been proven to be a significant source of economic growth.

 

(Also read: 11 Types of Economic Theory)

 

Benefits of economic growth

 

• Higher incomes

 

Consumers can buy more goods and services as a result of economic growth, and their living standards improve. Growth in the economy during the twentieth century was a major factor in lowering absolute poverty levels and allowing for an increase in life expectancy.

 

• Reduced unemployment

 

Because businesses will be producing more, higher economic growth will result in an increase in labour demand. As a result, unemployment will decrease, resulting in lower government spending on benefits and fewer social issues. 

 

If the economy is in a slump, increasing the rate of economic growth will be a critical step toward lowering unemployment.

 

• Standard of living

 

The benefit of economic growth is that people's living standards will rise. Economic growth can help to alleviate poverty by increasing people's income, allowing them to purchase basic necessities. 

 

When people have a lot of money, they can buy more luxury items, which boosts aggregate demand. This encourages businesses to produce more, which raises the economy's potential output level. 

 

When income and output rise, tax revenue rises as well, even if tax rates remain unchanged. The government can then spend more money on public services such as education and health care, which will improve people's standard of living.

 

• Improved public services

 

Higher tax revenues result from increased economic growth, allowing the government to spend more on public services such as health care and education, among other things. Higher living standards, such as increased life expectancy, higher literacy rates, and a better understanding of civic and political issues, maybe possible as a result of this.

 

• Economic development

 

Sustained economic growth is the most important factor in promoting economic development. Over the last few decades, economic growth in Southeast Asia has played a significant role in reducing poverty, increasing life expectancy, and enabling greater economic prosperity.

 
 

(Related reading: Economic growth vs economic development)