Studyledge

Economic Growth, Unemployment and Inflation: Question 6

Syllabus 4.5

Structured 11 marks

Larenth is a small economy.

  • Real GDP: Year 1 = L$180 billion; Year 2 = L$189 billion
  • Population: Year 1 = 40 million; Year 2 = 45 million

(a) Calculate the percentage change in Larenth's real GDP between Year 1 and Year 2. [2]

(b) Calculate real GDP per capita in Year 1 and in Year 2, and the percentage change in real GDP per capita between Year 1 and Year 2. [4]

(c) Using your answers to (a) and (b), explain why a rise in real GDP does not always mean that living standards in Larenth are rising. [2]

(d) Other than an increase in total spending, explain one other possible cause of an increase in real GDP such as the one calculated in (a). [3]

Show worked solution Hide worked solution

Worked solution

Part (a): Percentage change in real GDP

Percentage change=new value−old valueold value×100\text{Percentage change} = \frac{\text{new value} - \text{old value}}{\text{old value}} \times 100

189−180180×100=9180×100=5%\frac{189 - 180}{180} \times 100 = \frac{9}{180} \times 100 = 5\%

Larenth’s real GDP grew by 5%\boxed{5\%} between Year 1 and Year 2.

Part (b): Real GDP per capita

Real GDP per capita=Real GDPPopulation\text{Real GDP per capita} = \frac{\text{Real GDP}}{\text{Population}}

Year 1: 180,000,000,00040,000,000=4,500\frac{180{,}000{,}000{,}000}{40{,}000{,}000} = 4{,}500

Year 2: 189,000,000,00045,000,000=4,200\frac{189{,}000{,}000{,}000}{45{,}000{,}000} = 4{,}200

Percentage change in real GDP per capita: 4,200−4,5004,500×100=−3004,500×100≈−6.7%\frac{4{,}200 - 4{,}500}{4{,}500} \times 100 = \frac{-300}{4{,}500} \times 100 \approx -6.7\%

Real GDP per capita fell from L$4,500 in Year 1 to L$4,200 in Year 2, a fall of about 6.7%\boxed{6.7\%}.

Part (c): Why rising real GDP does not always mean rising living standards

Real GDP measures the total real value of output produced by the whole economy, while real GDP per capita divides this total by the population, giving a better indication of how much output is available per person, which is closely linked to living standards.

In Larenth, real GDP rose by 5%, but the population rose by an even larger 12.5% (from 40 million to 45 million) over the same period. Because population grew faster than output, the total output now has to be shared between more people, so the average amount of output, and by extension the average living standard, actually fell, even though the economy as a whole grew. This is why economists look at real GDP per capita, not just real GDP, when judging whether living standards are rising.

Part (d): Another cause of an increase in real GDP

Besides a rise in total spending, real GDP can rise because the economy’s productive capacity itself increases:

  • An increase in the quantity of resources: for example, more workers joining the labour force, or firms investing in new factories and machinery (more capital).
  • An increase in the quality of resources: for example, a better-educated and better-trained workforce, or firms adopting more efficient technology.

Either of these allows the economy to produce more output than before, raising real GDP even without any change in total spending.

Final answers

  • (a) Real GDP grew by 5% between Year 1 and Year 2.
  • (b) Real GDP per capita: L$4,500 (Year 1) → L$4,200 (Year 2), a fall of about 6.7%.
  • (c) Population grew faster (12.5%) than real GDP (5%), so output per person fell even though total output rose. Real GDP per capita is a better guide to living standards than real GDP alone.
  • (d) An increase in the quantity of resources (e.g. more workers or capital) or the quality of resources (e.g. better education or technology).