Understanding Compound Economic Growth

The first concept of economics that we will explore today is economic growth. Have you ever come across a newspaper article reporting the projected economic growth of your countries? It is arguably one of the most important data in the macroeconomic setting of Amercia. The number of economic growth can also play a decisive determinant of the success or failure of a political party in an election. So what exactly is economic growth? How can economists determine that a country’s economy is growing?

Source: http://www.israeltrade.org.au/wp-content/uploads/2011/03/economic-growth.jpg

Gross Domestic Product (GDP)

Before digging deeper into the concept of economic growth, the term gross domestic product (GDP) should be brought up. Basically, GDP is total value of goods and services produced within a country for a specific period of time. In other words, GDP is the total output produced in a country or simply known as national income. Notably, GDP is a common indicator of the health of a country’s economy. The larger the GDP in the present compared to the previous period, the better it shows that the economy is growing which could means people are getting richer. Yet there is always exception to economic theory. While GDP is a popular indicator of the economy’s health, it does not necessarily mean it is the best and always gets the job done, since GDP does not take into account many aspects of human development and well-being. Country A with a larger GDP than Country B does not necessarily translate into a better standard of living. For instance, China is the world’s number 2 economy. Its GDP is much larger than Luxembourg, but Luxembourg people relish a much much better lifestyle and living standard. It is straying away from our main topic “economic growth” and I will keep the focus on economic growth and I expect to explore GDP in the upcoming posts of the blog.

Fun Way with Growth Rate Calculation

Economic growth simply is the increase or decrease in the size of the economy. Below I will show you the simple way to calculate economic growth – a very easy calculation. Supposed that the size of the GDP of Country A in 2013 is X_T and GDP in 2014 is X_T+1. So what is the growth rate? An exercise for X_T your brain.

 g =  (X_{T+1  -} X_{T ) /} X_T

With this formula, we can modify it to calculate the size of the economy with the given economic growth: 

X_T+1 = X_T × (1+g)

Ok so now here come a brain exercise that is a bit more challenging. Now we will calculate the size of the economy X with a “g” economic growth for 2 years in a row:

X_T+2 = X_T+1 × (1+g)

                                                                   = [X_T × (1+g)] x (1+g)

                                                                   = X_T  × (1+g)²

Therefore, we can derive a simple formula to calculate compound economic growth

X_T+N = X_T × (1+g)^N

If you don’t believe in this formula, that’s fine. Try to come up with an example of your own and substitute the real example into the formula then you will have the correct answer.