Question

How is economic growth measured? Why is economic growth important? Why could the difference between a 2.5 percent and a 3 percent annual growth rate be of great significance over several decades?

Short answer

Economic growth is measured by an increase in real GDP per capita over a specific period.

Economic growth is necessary to attain economic goals such as increased standard of living, more employment, increased wage rates, poverty reduction, and many more.

A small change in growth rate can result in a larger variation in the GDP value over several decades and thus, has significance.

Step-by-step solution

Step 1. Meaning of economic growth and its measurement.

A rise in the inflation-adjusted market value of goods and services over a while is viewed as economic growth. It is measured in two ways:

• An increase in real GDP: GDP is measured as the market value of goods and services produced over a period of time in a specific place. Economic growth is measured by calculating the percentage change in base year GDP and current year GDP.

For example, if the base year value of GDP is $200,000 million and the current year GDP is $205,000 million. The economic growth would be:

$$\begin{gathered} Growth\%=\frac{\$205000-\$200000}{\$200000}\times 100 \\ =\frac{\$5000}{\$200000}\times 100 \\ =2.5\% \end{gathered}$$

• An increase in real GDP per capita: The real GDP per capita is determined by dividing the population by GDP to obtain real GDP per capita. Then the economic growth is measured by calculating the percentage change in the country’s per capita income from the base year to the current year.

For example, the GDP per capita of a country is $20,000 in the base year and $21,000 in the current year. The percent change in real GDP would be:

$$\begin{gathered} Growth\%=\frac{\$21000-\$20000}{\$20000}\times 100 \\ =\frac{\$1000}{\$20000}\times 100 \\ =5\% \end{gathered}$$

Step 2. Importance of economic growth

An increased economic growth reduces the burden of scarcity and ensures higher production of goods and services in the future. Economic growth is required to attain economic goals such as better standard of living, increased economy, higher employment level, increased real wage, etc. It ensures more welfare to the society.

Step 3. Significance of small change in annual growth rate over many decades

Suppose the GDP value of a country is $20,000 million. The country is experiencing a small growth of 0.5 percent each year. The value of a country’s GDP after 40 years is calculated below:

$$\begin{gathered} ValueofGDP\left(million\right)=\$20000\times 0.5\times 40 \\ =\$400000 \end{gathered}$$

The above calculation shows that after 40 years, the value of GDP reaches $400,000 million. In four decades, a small change of 0.5 percent of economic growth per year has added $380,000 million to the economy.

The example shows that an annual growth rate of 0.5 percent caused a huge change in the value of the country’s output. That’s why a small change in the annual growth rate has a huge significance on real GDP over several decades.