Adjustments for changes in inflation are factored into real GDP. This means that when inflation is high, real GDP is lower than nominal GDP, and vice versa. Positive inflation, without a real GDP adjustment, dramatically inflates nominal GDP.
What causes real GDP to rise?
A rise in aggregate demand drives economic growth in the short run (AD). If the economy has spare capacity, an increase in AD will result in a higher level of real GDP.
Factors which affect AD
- Lower interest rates – Lower interest rates lower borrowing costs, which encourages consumers to spend and businesses to invest. Lower interest rates cut mortgage payments, increasing consumers’ discretionary income.
- Wages have been raised. Increased real wages enhance disposable income, which encourages consumers to spend.
- Greater government expenditure (G), such as government investments in new roads or increased spending on welfare payments, both of which enhance disposable income.
- Devaluation. A decrease in the value of the currency rate (for example, the Pound Sterling) lowers the cost of exports and increases the volume of exports (X). Imports become more expensive as a result of depreciation, lowering the quantity of imports and making domestic goods more appealing.
- Confidence. Households with higher consumer confidence are more likely to spend, either by depleting their savings or taking out more personal credit. It encourages spending by allowing increased spending (C) (C).
- Reduced taxation. Consumers’ disposable income will increase as a result of lower income taxes, which will lead to increased expenditure (C).
- House prices are increasing. A rise in housing prices results in a positive wealth effect. Homeowners who see their property value rise will be more willing to spend (remortgaging house if necessary)
- Financial stability is important. Firms will be more eager to invest if there is financial stability and banks are willing to lend, and investment will enhance aggregate demand.
Long-term economic growth
This necessitates an increase in both AD and long-run aggregate supply (productive capacity).
- Capital increase. Investment in new manufacturing or infrastructure, such as roads and telephones, are examples.
- Increased labor productivity as a result of improved education and training, as well as enhanced technology.
- New raw materials are being discovered. Finding oil reserves, for example, will boost national output.
- Microcomputers and the internet, for example, have both led to higher economic growth through improving capital and labor productivity. New technology, such as artificial intelligence (AI), which allows robots to take the place of human workers, may be the source of future economic growth.
Other factors affecting economic growth
- Stability in the economy and politics. Stability is vital for convincing businesses that investing in capacity expansion is a sensible decision. When there is a surge in uncertainty, confidence tends to diminish, which can cause businesses to postpone investment.
- Inflation is low. Low inflation creates a favorable environment for business investment. Volatility is exacerbated by high inflation.
Periods of economic growth in UK
The United Kingdom saw substantial economic expansion in the 1980s, owing to a number of factors.
- Reduced income taxes increase disposable income, which leads to increased expenditure and, in turn, stimulates corporate investment.
- House prices rose, resulting in a positive wealth effect, equity withdrawal, and increased consumer spending.
What causes real GDP to rise or fall?
Customer Spending Trends Any decline in customer spending will result in a drop in GDP. Customers spend more or less depending on their disposable income, inflation, tax rate, and debt load. Wage growth, for example, stimulates consumers to make more expensive purchases, resulting in a rise in real GDP.
What happens to real income when real GDP rises?
Finally, evaluate the consequences of a rise in real gross domestic product (GDP) (GDP). Such an increase indicates that the economy is growing. As a result, looking at the implications of a rise in real GDP is the same as looking at how interest rates will change as a result of economic expansion.
GDP may rise for a variety of causes, which will be examined in more detail in the next chapters. For the time being, we’ll assume that GDP rises for no apparent reason and explore the implications of such a development in the money market.
Assume the money market is initially in equilibrium with real money supply MS/P$ and interest rate i$ at point A in Figure 18.5 “Effects of an Increase in Real GDP.” Assume, for the sake of argument, that real GDP (Y$) rises. The ceteris paribus assumption states that all other exogenous variables in the model will remain constant at their initial values. It means that the money supply (MS) and the price level (P$) are both fixed in this exercise. People will need more money to make the transactions required to purchase the new GDP, hence a growth in GDP will enhance money demand. In other words, the transactions demand effect raises real money demand. The rightward change of the real money demand function from L(i$, Y$) to L(i$, Y$) reflects this rise.
What factors influence real GDP?
Adjustments for changes in inflation are factored into real GDP. This means that when inflation is high, real GDP is lower than nominal GDP, and vice versa. Positive inflation, without a real GDP adjustment, dramatically inflates nominal GDP.
What happens to unemployment when real GDP rises?
Employment will rise as long as growth in real gross domestic product (GDP) outpaces growth in labor productivity. The unemployment rate will fall if employment growth outpaces labor force growth.
What happens if real GDP decreases?
When GDP falls, the economy shrinks, which is terrible news for businesses and people. A recession is defined as a drop in GDP for two quarters in a row, which can result in pay freezes and job losses.
Why is real GDP a better indicator of economic change over time?
Economists track real gross domestic product (GDP) to figure out how fast a country’s economy is developing without being distorted by inflation. They can more precisely estimate growth with the real GDP number.
What does a change in real GDP mean?
Nominal GDP fluctuations represent changes in both the quantity and price of products and services. To value the production of goods and services, real GDP employs constant (base-year) prices. Only changes in the quantity of goods and services are reflected in changes in real GDP.
What is the significance of real GDP?
GDP is significant because it provides information on the size and performance of an economy. The pace of increase in real GDP is frequently used as a gauge of the economy’s overall health. An increase in real GDP is viewed as a sign that the economy is performing well in general.