MACROECONOMICS BBA ECO 103

ECONOMIC GROWTH & GDP

FACULTY: Dr. Firdaus Khan, Associate Professor, Mumbai Campus

ECONOMIC GROWTH & GDP IN A NUTSHELL:

Economic growth occurs when there is a rise in the production of goods and services for a certain
period. Every economy goes through different phases of economic activity, called a Business Cycle.
Economic growth therefore can be high or low, positive or negative. GDP is the most popular measure
of economic growth, but it has it’s limitations

What Is Economic Growth?

Economic growth occurs when there is an increase in the total production of economic goods and
services in one period of time compared with a previous time period. It can be measured in Nominal or
Real vlaue. Economic Growth is understood in terms of National Income measures such as Gross
National Product (GNP) and Gross Domestic Product (GDP). Some alternative metrics are also used to
understand a country’s prosperity, namely Human Development Index (HDI) and Happiness Index.

Why is understanding Economic Growth Important?

The citizens of a country may ask, ‘are we better off?’ Economic growth can answer that question. It
refers to an increase in the aggregate production in an economy, as generally manifested through a
rise in national income. Often (but not necessarily) these aggregate gains in production correlate with
increased average production per additional labourer or per additional machine. That leads to an
increase in incomes, inspiring consumers to open up their wallets and buy more, which means more
jobs, a higher material quality of life and standard of living; lesser poverty. It can mean bigger
investments for businesses, more social protection and financial security for citizens.

Can Economic Growth be Negative?

Every economy moves through different periods of economic activity, called the “Business Cycle.” It
consists of four phases – Expansion, Recession, Depression and Recovery. There are two turning points
or inflection points – Peak and Trough. Since economic growth is measured through a nation’s income
through it’s cyclical economic activity, economic growth can be positive or it can be a negative

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number. This means total value added per year can be more than last year or it can be less than last
year, depending on the overall growth trend in the economy.

Understanding Business Cycles

Characteristics of business cycles (or different periods of economic activity):

• There are fluctuations of aggregate economic activity, measured by economic

indicators over time
• There is an alternating pattern of Expansion/Boom and Contraction/Recession
• Observations can be made about co-movements of many macroeconomic variables
over the business cycle
• Business Cycles are recurrent but not periodic

Business Cycle

Three types of economic indicators are used to track economic activity – leading indicators, coincident
indicators and lagging indicators. See details below. Governments and Central Banks actively try to
influence the direction of economic activity and economic growth through some strategies related to
availability and pricing of capital goods, labor force, technology, and human capital. They believe that
such strategies of Fiscal Policy and Monetary Policy can prevent an economy from falling into low
economic activity (Recession) or can nudge an economy to emerge (Recovery) out of low economic
activity.

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 Types of Economic Indicators

How is Economic Growth Measured?

To judge how a person is doing economically, income is a good measure. A person with a high income
can more easily afford life’s necessities and luxuries, better housing, better healthcare, fancier cars,
more opulent vacations, etc. The same logic applies to a nation’s overall economy. When judging
whether the economy is doing well or poorly, it is natural to look at the total income that everyone in
the economy is earning. That is the task of GDP. GDP measures two things at once: the total income
of everyone in the economy and the total expenditure on the economy’s output of goods and services.
GDP can perform the trick of measuring both total income and total expenditure because these two
things are the same. For an economy as a whole, income must equal expenditure because of the
circular flow of income – one person’s expenditure is another person’s income. See diagram below:

Circular Flow of Income

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 Generally, there are four economic decision makers within an economy - Households, Firms,
Governments and Foreigners. The spending that is directly connected with each of these decision
makers is consumption (C), investment (I), government spending (G), and net exports (X-M). Hence,

GDP = C + I + G + (X - M)

Gross Domestic Product = Consumption + Investment + Government Spending + (Exports - Imports)

Furthermore, total increase in economic activity needs to be adjusted for price changes, hence the
Nominal GDP is adjusted for inflation to give us Real GDP. Nominal GDP represents 'current quan``es
at current prices.' Real GDP, on the other hand, represents 'current quan``es at past prices,' so it tells
us how much produc`on really increased from one year to the next, ignoring rising prices.

Limitations of GDP

Measuring the value of a commodity is tricky. Some goods and services are considered to be worth
more than others – compare a smartphone with a pair of socks. So growth has to be measured in the
‘value’ of goods and services, not merely total quantity. However, value is subjective and tricky to
standardize. People in Finland may find a heater is more valuable than those in Africa. Also, it is
important to remember that GDP is not a measure of accumulated wealth. Poor countries can have
high GDP rates, rich countries can have low GDP rates. GDP also does not tell us how fairly these goods
and services were distributed in society. Also, in calculating the value of economic activities, GDP does
not factor in any environment costs. Overfocusing on GDP means merely looking at the short term,
ignoring long term issues of inclusion and sustainability, happiness and human development.

Key Takeaways

1. Economic growth reflects prosperity. However, it can be cyclical having 4 phases: expansion,
recession, depression and recovery.
2. Fiscal Policy and Monetary Policy try to influence economic activities and economic growth.
3. GDP, a measure of economic growth, is the increase in aggregated market value of additional
goods and services produced by a country in a year.
4. By expenditure approach, GDP = C + I + G + (X - M)
5. Nominal GDP is adjusted for inflation to get Real GDP. Nominal GDP is 'current quan``es at
current prices’ but Real GDP is 'current quan``es at past prices.’
6. GDP is not a measure of accumulated wealth, it is only a short-term measure. It does not
reflect aspects of inclusion, sustainability, opportunity cost and tradeoffs.

SOURCES:
• Investopedia (2021). What Is Economic Growth and How Is It Measured? Investopedia.com.
https://www.investopedia.com/terms/e/economicgrowth.asp
• Case, K. E., Fair, R. C., & Oster, S. E. (2019). Principles of macroeconomics, global edition. Pearson
Education Limited

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 • Hoang, P., & Ducie, M. (2018). Cambridge IGCSE and O Level Economics 2nd edition.
Hachette UK.

firdaus.khan@spjain.org