Growth or decline in the gross domestic product (GDP)tends to be
measured in terms of a percentage. For example, economists might say
that the GDP grew by 4% in a given quarter.  However, even if the
economy grows by the same amount of dollars each quarter, the
percentage of growth will decrease because the same amount of dollar
growth each quarter will be a smaller and smaller percentage of the
whole. This creates the impression that economic growth is slowing
when it is really remaining constant.

How do economists compensate for this fact when measuring the growth
rate of the economy?

Hello halerjb,

Thanks for the interesting question! Let me give you the brief answer
first and then I will provide some links for you to continue your
research.

The fact is that, actually, the economy does not grow by the same
dollar amount each quarter; rather, it grows as for the percentage
stated by the economists. Let me clarify:

Imagine the GDP of a country is $1000 at the beggining of the year. If
it were to grow by the same dollar amount each quarter (say, $100),
then you would be right:
Growth in 1st quarter: (1,100-1,000)/1,000= 10%
Growth in 2nd quarter: (1,200-1,100)/1,100= 9.09%
Growth in 3rd quarter: (1,300-1,200)/1,200= 8.33%
and so on...

However, when you read that a country has experienced, say, a 10%
growth in its GDP, it means exactly that: that the GDP this quarter is
equal to the previous quarter GDP plus 10% of the previous quarter
GDP.

Growth in % = (GDPnow-GDPprevious)/(GDPprevious)*100

So if USA grows at 2% each quarter, even though the growth rate is
constant, the dollar amount is growing; actually, it's growing faster
and faster each quarter. As an example:

Initial GDP = $1000
Growth = 5% each quarter

Dollars initally=$1000
Dollars at the end of 1st quarter= $1000 + 0.05*$1000= $1050
Dollars at the end of 2nd quarter= $1050 + 0.05*$1050= $1102.50
Dollars at the end of 3rd quarter= $1102.5 + 0.05*$1102.5= $1157.62

If you look at the dollar amount growth, you'll see that first it
grows by $50, then by $52.50, then by $55.12, etc. A constant growth
rate means that the dollar amount change is becoming larger.

The reason why economists use growth rates (percentages) instead of
measuring growth in terms of dollar amounts, is that naturally,
countries (or states within the USA, for example) with a large GDP
tend to experience a large dollar amount growth, but not necessarily a
large growth rate. To see this, compare the USA to a very small
country: for the USA, a growth in the GDP of $20 billion is not
uncommon, or even small if you see how the USA's GDP grew during the
90's; however, for a very small country, a growth of $20 billion could
be a miracle.

This suggests that the dollar amount growth is not a good measure of a
country'sperformance; the growth rate is better. In the example of the
previous paragraph, even though the dollar amount growth for the USA
and the small country was exactly the same, you would say that the
small country did much better than the USA: it achieved the same
dollar amount growth with far less resources. This would be reflected
in the percentage growth rate, which would be larger for the small
country than for the USA.

So, again, economists need not compensate for the fact you mention
when measuring economic growth. A constant dollar amount growth (which
means a declining a growth rate measured in percentage) is actually a
sign that the country's growth is slowing down, hence the use of the
growth rate.


For further topics on economic growth, you may want to check

Economic Growth: Introduction
http://william-king.www.drexel.edu/top/prin/txt/gro/gro0a.html
(click 'Next' to get to the interesting part)

Or, if you have access to a library, try looking for
"Macroeconomics - 5th edition", By R. Barro, 1997
http://www.amazon.com/exec/obidos/ASIN/0262024365/qid=1024543997/sr=8-1/ref=sr_8_1/102-0211582-8583357


I hope you now have a better understanding of how economic growth is
measured. If you need further assistance, don't hesitate to request a
clarification.

Best wishes,

elmarto-ga

---

Request for Answer Clarification by halejrb-ga on 20 Jun 2002 09:15 PDT

Your answer implies that large economies (and large companies)will
find it increasing difficult to maintain a high rate of growth because
it will take more and more quantitative growth to maintain the same
percentage of growth.  Do you concur?

---

Clarification of Answer by elmarto-ga on 21 Jun 2002 20:26 PDT

Hello halerjb!

Thanks for your question. I don't think that large companies/economies
have ever increasing trouble sustaining a high growth rate, because
"quantitative" growth depends on how large the economy is.

I believe that most of an economy's growth rate depends on the
improvement of technology. So, imagine there's a technological
improvement (for example, the appearance of computers). Do you think
it would have a higher quantitative impact in a poor country or in a
rich country? Clearly, in a rich country, more people would have
access to computers, generating a certain quantitave growth. In poor
countries, computer use would not be as common, so quantitative growth
would not be as large. Nonetheless, the same technological shock might
still generate an equal percentage growth rate for both economies.

So, in principle, there's no reason why growing economies or companies
should have more and more trouble sustaining there growth. In fact, if
you look at growth data in the 90s, you'll see that the US
outperformed mostly every poorer country in terms of growth. This is
an example of a large economy sustaining higher growth rates than
poorer economies.

I hope this clarifies your question. If you need further
clarification, please feel free to ask.

Best wishes,

elmarto-ga

This is a very good answer.  It would have gotten 5 stars if the
researcher had answered my follow up question.  Thanks to all who
commented too.

My comment on your request for clarification:

Think of growth as coming from a larger number of viable business
plans -- more valid knowledge in a larger number of heads. If we start
off where only a few people have assets and the knowledge of how to
build a company to serve some particular need or desire, only a small
amuont of credit (lending) will take place too those people. But the
people who work for those initial companies will get knowledge of how
to run a business, and will also be accumulating assets. Eventually
they will also be able to get a loan and start a business. The more
money there is in the economy, the more loans we can make. Every act
of creating a loan is an act of creating money -- of increasing money
supply. Take a look at http://www.stls.frb.org/fred/data/wkly/totbkcr
to see that the total amount of credit continually expands.

As long as the credit quality is good (i.e. a large enough number of
enterprises succeed) money supply growth does not have bad side
effects. If lending increases beyond the number heads that have the
correct knowledge (whatever that may be) to build a successful
business, then inflation will negate the growth and can lead to a
negative spiral.

I do not agree that it is hard for an economy to maintain a rate of
growth as long as the rate of correct knowledge to build successful
businesses also grows. If one person can train 2 people, then those
two can train 2 each, and so on. This should result in exponential
growth, but as competition increases the percentages of business plans
that fail may also increase. But steady growth rates should be
possible. Marx thought once people's needs were satisfied capitalism
would collapse, but as we see, there are no limits to the number and
variety of things we desire. Desire creates economic demand, and the
possibility of more successful business plans.

The problem of poverty is a serious one though, and results from a
disadvantaged person or someone laid off from an obsolete industry not
having the knowledge of (a) what new skills are useful and compatible
with his abilities (b) who teaches those skills best and (c) who would
finance the re-training investment. In my book "Zen and the Art of
Funk Capitalism" I call this the meta-knowledge problem and show how
it can be resolved by creating institutions like Fannie Mae (which
make it possible for nearly anyone to get a mortgage loan in the US)
for creating liquidity for adult training loans. The loan officers
would then constantly be looking for disadvantaged people and give
them a loan that is appropriate and show them the people who train the
best.

-kp

I'm so sorry.  elmarto-ga DID answer the follow up question and I just
didn't notice.  I wish I'd given him/her 5 stars.  The answers
deserves it.