What this lesson teaches
I can define economic growth.
Syllabus K343, 4.5.1. Definition of economic growth
I can explain how real GDP measures economic growth.
Syllabus K343, 4.5.2. Measurement of economic growth: real Gross Domestic Product (GDP)
Make a guess
Nominal GDP rises by 5% and prices rise by 3%. How much more did the economy actually produce?
- 5% more, the rise in nominal GDP.
- 8% more, adding the two rises.
- About 2% more.
Show the answer
About 2% more.
Nominal GDP counts higher prices as if they were extra output. Removing the 3% price rise leaves about 2% real growth.
Economic growth is an increase in real GDP: the value of output after removing the effect of price rises.
Economic growth is an increase in the output of goods and services in an economy over time. It is measured by the change in real Gross Domestic Product (GDP).
GDP is the total value of all goods and services produced in a country in a year. Nominal GDP uses current prices, so it rises when prices rise even if output does not. Real GDP removes the effect of inflation, so it shows the change in actual output.
The growth rate is the percentage change in real GDP from one year to the next.
If nominal GDP rises by 5% and prices rise by 3%, real GDP rises by about 2%. Only that 2% is extra output.
- Economic growth
- Increase in real GDP over time.
- GDP
- Total value of goods and services produced in a country in a year.
- Real GDP
- GDP adjusted to remove the effect of inflation.
Worked example: Calculating a growth rate
Suppose a country's real GDP rises from $400 billion to $412 billion in a year.
- Change in real GDP = 412 - 400 = $12 billion.
- Growth rate = 12 / 400 x 100 = 3%.
- This means the country produced 3% more goods and services than the year before.
- If the figures had been nominal, part of the rise could just be higher prices.
Try it step by step
Problem 1
Nominal GDP is $400 billion in year 1 and $436.8 billion in year 2. The price index is 100 in year 1 and 104 in year 2.
Show the working
- Real GDP in year 2 (at year 1 prices): $436.8bn / 1.04 = $420 billion
- Change in real GDP: $420bn - $400bn = $20 billion
- Real growth rate: $20bn / $400bn x 100 = 5%
Problem 2
Nominal GDP is $250 billion in year 1 and $275.4 billion in year 2. The price index is 100 in year 1 and 108 in year 2.
Show the working
- Real GDP in year 2 (at year 1 prices): $275.4bn / 1.08 = $255 billion
- Change in real GDP: $255bn - $250bn = $5 billion
- Real growth rate: $5bn / $250bn x 100 = 2%
Problem 3
Nominal GDP is $600 billion in year 1 and $636.3 billion in year 2. The price index is 100 in year 1 and 105 in year 2.
Show the working
- Real GDP in year 2 (at year 1 prices): $636.3bn / 1.05 = $606 billion
- Change in real GDP: $606bn - $600bn = $6 billion
- Real growth rate: $6bn / $600bn x 100 = 1%
Watch out for this
If GDP measured in current prices rises, the economy must be producing more.
Nominal GDP can rise just because prices rose. Real GDP removes inflation and shows whether output really increased.
Check your understanding
A country makes 4% more goods and services this year, and their average price falls by 1%. What happens to the money value of its output (nominal GDP)?
- It goes up by about 3%.
- It goes up by about 5%, adding both.
- It falls by about 1%.
Show the answer
It goes up by about 3%.
Right. Nominal GDP reflects both changes: about 4% more output at about 1% lower prices.
Check your understanding
A country's nominal GDP rose by 7% in a year, and the general price level rose by 3%. Approximately what was the rate of real economic growth?
- 4%
- 3%
- 10%
- 7%
Show the answer
4%
Right. Real growth is roughly nominal growth minus inflation: 7% - 3% = 4%.
Check your understanding
Real GDP rises from $200 billion to $210 billion while the population rises from 5.0 million to 5.1 million. What happens to real GDP per head?
- It falls by about 2%
- It rises by about 3%
- It rises by 7%
- It rises by 5%
Show the answer
It rises by about 3%
Right. It rises from $40,000 to about $41,176 per head, an increase of about 2.9%.