2.1.1 Economics Growth

Topic 2.1.1: Economic Growth (Master Notes)

1. Defining and Measuring Economic Growth

Economic growth is the increase in the capacity of an economy to produce goods and services, compared from one period of time to another.

A. Rates of Change of Real GDP

  • GDP (Gross Domestic Product): The total value of all goods and services produced within a country’s borders in a specific time period.

  • Economic Growth Rate: Calculated as the percentage change in Real GDP.

    • $\text{Growth Rate} = \frac{\text{New GDP} - \text{Old GDP}}{\text{Old GDP}} \times 100$

  • Short-run Growth: An increase in Real GDP (movement from a point inside the PPF to a point closer to the boundary).

  • Long-run Growth: An increase in the productive capacity of the economy (a rightward shift of the LRAS or the PPF boundary).

B. Essential Distinctions

To score high marks, you must distinguish between these terms:

  • Real vs. Nominal:

    • Nominal GDP: Measured at current market prices; it does not account for inflation. It can be misleading if prices rise but output stays the same.

    • Real GDP: Adjusted for inflation using a GDP deflator. It reflects the actual volume of production.

  • Total vs. Per Capita:

    • Total GDP: The overall size of the economy.

    • GDP Per Capita: $\frac{\text{Total GDP}}{\text{Population}}$. This is a better indicator of individual living standards. If GDP grows by 2% but the population grows by 3%, GDP per capita actually falls.

  • Value vs. Volume:

    • Value: The monetary worth of goods/services (Price $\times$ Quantity).

    • Volume: The physical quantity of goods/services produced.

C. Gross National Income (GNI)

GNI is GDP plus net income from abroad.

  • It includes profits from domestic companies operating overseas and wages sent home by workers abroad (remittances).

  • Formula: $GNI = GDP + (\text{Income from citizens/assets abroad} - \text{Income sent to foreigners by domestic assets})$.

  • Significance: For countries with many citizens working abroad (like the Philippines) or many foreign corporations (like Ireland), GNI is a more accurate measure of the "wealth" available to citizens than GDP.

2. International Comparisons and PPPs

D. Comparison over time and between countries

  • Over Time: We use index numbers to see trends. A "Base Year" is set at 100, and subsequent years are expressed relative to that.

  • Between Countries: Usually converted into a common currency (typically the US Dollar). However, simple exchange rate conversion is flawed because it doesn't account for what that money can actually buy in a local shop.

E. Purchasing Power Parities (PPPs)

  • Definition: An exchange rate that equalizes the purchasing power of different currencies by eliminating the differences in price levels between countries.

  • The "Big Mac Index" Logic: If a Big Mac costs £4 in the UK and $5 in the US, the PPP exchange rate should be $£1 = \$1.25$.

  • Importance: PPP-adjusted figures are vital for comparing living standards. In developing nations, services (like haircuts or transport) are often much cheaper; therefore, a person earning $1,000 in India has a higher standard of living than someone earning $1,000 in NYC.

3. Limitations of GDP as a Measure of Living Standards

F. Why GDP is a flawed proxy for "Wellbeing"

  1. Hidden/Black Economy: Unrecorded transactions (cash-in-hand, illegal trade) are not in GDP. This can be up to 15% of GDP in the UK and much higher in developing nations.

  2. Inequality: GDP per capita is an average. It doesn't show if the top 1% holds all the wealth while the rest live in poverty.

  3. Non-Marketed Output: DIY, childcare provided by parents, and volunteer work have value but add $£0$ to GDP.

  4. Negative Externalities: GDP counts the value of the chemicals produced but ignores the pollution (and resulting health costs) created in the process.

  5. Quality of Life: GDP doesn't measure leisure time, freedom, or the quality of public services.

4. National Happiness and Subjective Wellbeing

G. UK National Wellbeing

Since 2011, the UK’s Office for National Statistics (ONS) has measured "National Wellbeing" alongside GDP. They ask four key "subjective" questions regarding:

  1. Life Satisfaction (How satisfied are you with your life nowadays?)

  2. Worthwhile (To what extent do you feel the things you do in your life are worthwhile?)

  3. Happiness (How happy did you feel yesterday?)

  4. Anxiety (How anxious did you feel yesterday?)

The Relationship between Real Income and Subjective Wellbeing

  • The Easterlin Paradox: This theory suggests that at low levels of income, a rise in income leads to a significant increase in happiness. However, once a "saturation point" is reached (where basic needs are met), further increases in real income do not lead to significant increases in happiness.

  • Relative Income: Happiness often depends more on how much we earn compared to our peers (social comparison) than on our absolute level of wealth.

Evaluation: Is Economic Growth always good?

  • Pros: Lower unemployment, higher tax revenue for the government (fiscal dividend), higher living standards.

  • Cons: Potential inflation (demand-pull), environmental degradation, increased stress, and widening income inequality.