CH 3 (Measuring Economic Growth) Part 1

Econ 303
ECONOMIC DEVELOPMENT & PLANNING
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3) Measuring Economic Growth
Introduction
Macroeconomists use different means to study and explain how the economy
as a whole functions and changes over time. The two mostly used measures
are the Gross Domestic Product (GDP) and the Consumer Price Index (CPI).
The GDP measures the market value of goods and services produced and the
total income within a country. The CPI measures the total cost of goods and
services purchased by a typical consumer within a country. Both of the GDP
and CPI are very useful in illustrating how much income exists within an
economy and how much this income can purchase goods and services needed
to satisfy people’s needs and desires.
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I. Gross Domestic Product (GDP)

GDP represents the summation of the following parts of the economy:
consumer spending, government spending, investments, and net exports,
as represented by the equation:
Y = C + G + I + NX
1.1 Calculating Nominal GDP, Real GDP and GDP Deflator
**Nominal GDP : is measured in actual current market prices,
** Real GDP: is the sum value of all produced goods and services at
constant prices (i.e. prices of a base year).
** GDP Deflator: represents the ratio of nominal GDP to real GDP for a
given year minus 1. It illustrates how much of the change in the GDP from
a base year is dependent on changes in the price level, so we can
calculate the real increase in the GDP.
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Example:
Use the following data to calculate Nominal GDP, Real GDP and, GDP
deflator:
year Quantity A Price A Quantity B Price B
1 50 2 70 3
5 65 2.2 75 3.4
A) Calculating Nominal GDP

Nominal GDP for year 1= (50 X $2) + (70 X $3) = $310
Nominal GDP for year 5 = (65 X $2.2) + (75 X $3.4) = $398
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B) Calculating Real GDP
The first step to calculate real GDP is choosing a base year.

For example, to calculate the real GDP for year (5) using year (1) as the
base year, use the GDP equation with year 5 quantities and year 1 prices:
Real GDP for year 5 = (65 X $2) + (75 X $3) = $355
C) Calculating GDP deflator

GDP deflator = (nominal GDP / real GDP) -1
= ($398 / $355) -1 = 0.121 = 12.1%
This means that the price level increased by 12.1% from year (1), the
base year, to year (5), the comparison year.
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1.2 Calculating economic growth
A) Calculating the Final Value of output (Yt)

Suppose that the value of output in a certain year is $100,000 which
is growing at 6% annually. Calculate the gross value of output after 5
years.
Since Yt = Y1 (1+ r)t
then Y5 = $100,000 (1 + .06)5 = $133,822
B) Calculating the value of the growth (increase) of output
Using the above example, we can measure the total growth from
a base year (year 1) to a later year (year 5) as follows:
The value of output growth = $133,822 - $100,000 = $33,822
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C) Calculating the cumulative (overall) growth rate

Using the above example, we can measure the percentage of change
in Y from year (1) to year (5) as follows:
The cumulative growth rate
= ($33,822 / $100,000)*100 = 33.82%
D) Calculating the rate of average annual growth (r)
If the value of output in year (1) equals $120,000, and equals
$180,000 in year (5), then the rate of average annual growth
can be calculated using the following equation:
Since Yt = Y1 (1+ r)t
then (1+ r)t = (Yt/Y1)
(1+ r) = (Yt/Y1)(1/t)
r = (Yt/Y1)(1/t) – 1
r = ($180,000 / $120,000)1/5 – 1 =
r = 1.0844 – 1 = 0.0844 = 8.44%
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E) Calculating the period ( t) needed to reach certain output level

Suppose that output level of year (1) is $100,000, and annual
growth rate is 7%, calculate how long it will take this output level to
reach $210,000.
Calculating the number of years requires applying logarithms to the
original equation as follows:
Yt = Y1(1+r)t
log(Yt) = log(Y1) + t [log(1+r)]
t [log(1+r)] = log(Yt) - log(Y1)
t = [log(Yt) - log(Y1)] / log(1+r)
= log(Yt/Y1) / log(1+r)
= log($210,000 / $100,000) / log(1 + 0.07)
= log (2.1) / log (1.07) = 0.322 / 0.029 = 11 years.
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1.3 Gross Domestic Product vs. Gross National Product
GDP and GNP are the mostly used measures of the total output of an
economy. As indicated earlier, GDP, is the total value of all goods and
services produced within a country. GNP is the sum value of all goods and
services produced by nationals of a country regardless of their
location. The important distinction between GDP and GNP rests on
differences in counting production by foreigners in a country and by
nationals outside of a country.
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GDP and GNP calculations

Using data in the following table, we can calculate both GDP
and GNP for country A as follows:
GDP for year 1 = (230 + 40) + (175 + 35) = $480
GDP for year 2 = (210 + 65) + (200 + 45) = $520

GDP growth rate = (520 – 480) / 480 = 8.3%
GNP for year 1 = (230 + 25) + (175 + 20) = $450
GNP for year 2 = (210 + 30) + (200 + 35) = $475
GNP growth rate = (475 – 450) / 450 = 5.5%
Value (million $)of food outputs produced by Value (million $) of clothes output produced by
Year
Nationals Nationals Foreigners Nationals Nationals
Foreigners
in the country outside the in the in the country outside the
in the country
country country country
1 230 25 40 175 20 35
2 210 30 65 200 35 45
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1.4 Per Capita GDP vs. Per capita GNP
GDP per capita is equal to the GDP divided by the size of population.
The GNP per capita equals the value of GNP divided by the number of
population. Economists usually use these numbers to represent the
standard of living. In general, the higher GDP per capita in a country,
the higher the standard of living.
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Calculating GDP and GNP per capita

Using data in the following table, we can calculate per capita GDP
and GNP as follows:
Number of
Year GDP GNP
population
17.2 148,000 145,000

1
17.9 180,000 166,500
2
Per capital GDP for year 1=148,000 / 17.2 = $8,604.6
Per capital GDP for year 2=180,000/ 17.9= $10,066.9
Per capita GDP growth rate=($10,066.9-$8,604.6)/$8,604.6= 17%
Per capital GNP for year 1=145,000 / 17.2 = $8,430.2

Per capital GNP for year 2 = 166,500 / 17.9 = $9,301.7
Per capita GNP growth rate =($9,301.7-$8,430.2) / $8,430.2 =10.3%
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Limitations of per capita GDP and GNP

GDP and GNP per capita measures have been criticized for
a number of reasons including the following:
a) they do not measure changes in output due to changes in
prices;
b) they do not show whether the increase in income goes to the
rich or the poor;
c) they do not take into account the availability of basic needs
such as: nutrition, health, sanitation, housing, education; and
d) when these measures are used to compare among countries,
the difference in the exchange rates of their currency's is not
taken into account.
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To be continued 

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Econ 303

ECONOMIC DEVELOPMENT & PLANNING

I. Gross Domestic Product (GDP)

year Quantity A Price A Quantity B Price B

A) Calculating Nominal GDP

B) Calculating Real GDP

The first step to calculate real GDP is choosing a base year.

Real GDP for year 5 = (65 X $2) + (75 X $3) = $355

C) Calculating GDP deflator

1.2 Calculating economic growth

A) Calculating the Final Value of output (Yt)

C) Calculating the cumulative (overall) growth rate

E) Calculating the period ( t) needed to reach certain output level

1.3 Gross Domestic Product vs. Gross National Product

GDP and GNP calculations

GDP for year 2 = (210 + 65) + (200 + 45) = $520

1.4 Per Capita GDP vs. Per capita GNP

Calculating GDP and GNP per capita

17.2 148,000 145,000

Per capital GNP for year 1=145,000 / 17.2 = $8,430.2

Limitations of per capita GDP and GNP

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