How is Economic Growth Measured

Before going into learning how to measure the economic growth, let us see what economic growth is.

What is Economic Growth?

Economic growth can simply be defined as an increase in the value of production of goods and services by particular economy over a time, which can be proven by continuous rise in Gross Domestic Product (GDP). This is one of the most perennial target of an economy since it determines the overall wealth in terms of production and consumption of a nation.

How is Economic Growth Measured?

Economic growth is measured by the percentage rate at which the annual increment of GDP changes during given time periods, usually in real terms; i.e. with the impact of inflation adjusted. There are some other related indicators that are widely used in measuring economic growth such as Gross National Income (GNI) and Gross National product (GNP), which are also derived from the key measure, GDP. More importantly, economic growth can be measured using per capita GDP, taking the number of population in a particular economy into consideration.

There are two causes that affect the rise of GDP over time.

  • Increase in available resources within the economy
  • Increase in efficiency of the production

The value of the GDP of a particular economy is arrived from the data of National Accounts such as the annual data on production, consumption, investment, income, and expenditure of each economic sector. There are three different approaches to measure the GDP in an economy.

  • The Product / Output Approach
  • The Income Approach
  • The Expenditure Approach

Product / Output Approach of Measuring the GDP

The product / output approach of calculating GDP stresses the importance of value-adding activities of the production process of an economy. This approach tries to measure the market value of goods and services produced, disregarding the value of goods and services that are being used in the immediate stages of the production. Hence, the value of an economic activity is calculated as,

Market Value of the Outputs Produced – Value of Inputs purchased by other Producers

Then, the GDP under the output approach will be the aggregation of the added values of all these economic activities in every economic sector with the subsequent adjustments for taxes and subsidies on such production. This can be calculated as follows.

GDP = Total Output of the Economic Activities at Market Price – Intermediary Good and Service Consumption + (Taxes – Subsidies)

Income Approach of Measuring the GDP

Under Income Approach, to measure the economic growth, all the income received by the output producers will be summed up. This includes wages received by the workers, as well as the profits obtained by the owners of different firms. This can be calculated as follows.

GDP = Employment Income + Self-Employment Mixed Income + Total Profits Gained by Businesses + Taxes on Production and Imports of Goods and Services – Subsidies on Production and Import of Goods and Services

Expenditure Approach of Measuring the GDP

In contrast, the Expenditure Approach measures the GDP by adding different expenses spent on purchasing those goods and services by the residential economic units of a nation. The formulation of this method can be illustrated as,

GDP = Expenditure on Household Consumption + Value of Investments Spending by Business and Households + Expenditure of Government Institutions on Purchasing Goods and Services

Theoretically, all these approaches should produce similar results after relevant adjustments for depreciation, net factor income, net exports, and GDP deflation are made because the same phenomenon is measured using different perspectives. Therefore, if the numbers of products and services produced in an economy increase, incomes generated by producing such outputs and the expenditures spent on purchasing such outputs will be the same.

Limitations of Using GDP as a Measure of Economic Growth

There are several criticisms towards using GDP as an Economic Growth Indicator, since it does not provide any explanation for equal distribution of the expanded quantity of output and some other quality phenomenon. Also, it does not take into consideration the environmental impact of such output raise.

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