Real Economic Growth Rate - Explained
What is the Real Economic Growth Rate?
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Table of ContentsWhat is the Real Economic Growth Rate?How is the Real GDP Growth Rate used?Calculating the Real GDP Growth RateHow Real Economic Growth Works Calculating Real Economic Growth Rate FormulaUses of Real Economic Growth RateAcademic Research on the Real Economic Growth Rate
What is the Real Economic Growth Rate?
The economic growth rate is a kind of rate which measures the countrys economic growth in relation to the gross domestic product (GDP), in each periodic year. GDP refers to the value of the market of all goods and services transacted for a particular period of time in a country.
- The economic growth rate is a kind of rate which measures the countrys economic growth in relation to the gross domestic product (GDP), in each periodic year.
- Note that the Bureau of Economic Analysis (BEA) makes use of real GDP to measure GDP growth rate of the United States.
- In a business cycle, there are usually change in the GDP growth rate, which occurs in four phases; peak, trough, expansion, and contraction respectively.
How is the Real GDP Growth Rate used?
The real GDP growth rate is a more useful measure than the nominal GDP growth rate because it considersthe effectofinflationon economic data. The real economic growth rate is a "constant dollar" figureand, therefore, avoids the distortion from periods of extreme inflation or deflation and is a more consistent measure.
Calculating the Real GDP Growth Rate
The major role of the GDP growth rate is to measure the rate at which an economy grows. This is by comparing the GDP of a country to the previous year. In other words, it measures the nations economic output. Though there are four GDP components, personal consumption remains the key component of GDP growth. The other components include;
- Business investment
- Government spending
- Net trade
How Real Economic Growth Works
Note that in a business cycle, there are usually changes in the GDP growth rate which occurs in four phases. We have the peak, trough, expansion, and contraction respectively. In an economy where there is expansion, there is a positive growth rate in GDP as a result of businesses growing and jobs being created to increase productivity. However, note that the economic growth may come to a stall when the GDP growth rate happens to go beyond (exceed) 3 percent or 4 percent (this is called peak). On the other hand, contraction happens when a negative GDP growth rate is experienced and the businesses put on hold the hiring process as well as investing. When this happens, the consumer expenditure will significantly reduce because they have less money. The country comes under a recession when the GDP growth rate is negative. When the negative growth continues, then the GDP hits what we call the trough. After the trough period is over, the GDP will start positive growth all over again.
Calculating Real Economic Growth Rate
The Bureau of Economic Analysis (BEA) makes use of real GDP to measure GDP growth rate of the United States. Note that it is the real GDP which takes into account the inflation effect. Most GDP growth rates have their report done on a quarterly basis, however, it is usually annualized by BEA. This is to enable BEA to make a GDP growth rate comparisons to the previous years. Generally, when BEA reports the GDP growth rate of a given quarter yearly, it eliminates the effect of seasons. BEA does this so as to avoid a huge skip in GDP as well as in the growth rate in each 4th quarter. The reason behind this is that the fourth quarter in which the holiday season falls, experience massive shopping compared to other quarters. Such holiday season usually accounts for the big part of annual consumption among individuals.
GDP product refers to the amount spent by the; consumer, business, government, and the total exports subtracting the total imports. The calculation which factors inflation to get real GDP is as shown below: Real GDP = GDP/ (1 + Inflation since base year) Base in this formula refers to a chosen year in which the government does periodic updates and also used when comparing economic data like the GDP. To calculate the real GDP growth rate, you will base your calculation on real GDP figures as shown below: Real GDP growth rate = (most recent years real GDP - the last years real GDP) / the previous years real GDP.
Uses of Real Economic Growth Rate
- Real economic growth rate helps the governments policymakers to make fiscal policy decisions.
- Also, the economic growth rate can be used to control economic inflation or boost economic growth.
- In addition, it helps to compare the growth of the same economies whose inflation rates differ.