Handout week 1 Calculating real economic growth.

This handout is about calculating real GDP using nominal GDP and inflation. In addition, it explains how
you can correct economic growth for population development.

GDP

Real Gross Domestic Product (GDP) is a modification to the basic calculation of gross domestic product
(GDP). Real GDP is usually used to measure the size and growth of a country's economy. Real GDP
implies that the nominal GDP should be adjusted for inflation.

With real GDP in value, you can compare the size of a country's economy with that of another country.
Real GDP is also used to see how a country's economy is growing (or shrinking) over time and at what
stage of the business cycle a country has landed (as in the narrow definition of the business cycle based
on quarterly figures).

To see whether GDP growth leads to an increase in GDP leading to an increase in disposable income, you
also need to include population growth or shrinkage in your calculation. (See "Economics" chapter 7
"Real life numbers)

Method of calculating GDP:

In the course General Economics 1, we saw that GDP can be calculated in three ways:

1. Expenditure approach:

GDP = Consumption + Investments and households + Government expenditure + the balance of exports -
imports.

2. Production approach:

GDP = total turnover of companies and government minus the purchase value of goods and services.

3. Income approach:

GDP = rewards received by the factors of production plus depreciation.

Calculation real GDP from nominal GDP:

The following formula is used to calculate inflation in real GDP:

Real GDP = GDP / (1 + inflation since base year)

Example:

Real GDP of the Netherlands in 2016: 702.6 billion euros

Real GDP of the Netherlands in 2015: 683.5 billion euros

Inflation rate in 2016: 0.32%

To calculate the real GDP growth rate, you take two steps:

1. You use the formula (new - old / old)* 100 to calculate the percentage nominal growth (or
shrinkage) of the economy:

(702.6-683.5 / 683,5) * 100 = 2.7944%. Rounding to one decimal place makes 2.8%. Nominal GDP
increased by 2.8% in 2016.

A growth rate of 2.8% means a nominal index (NI) of 102.8

2. In order to calculate the real growth figure, you can use the RI/NI/PI formulas. RI is the real
index. NI is the nominal index. PI is the price index.

If NI and PI are calculated, they can be entered in the following formula. This is then followed by the RI.

RI = NI/ PI 100

NI = (RI PI)/ 100

PI = NI = NI/ RI 100 100

RI = real index

NI = nominal index = 102.8

PI = price index = 100.3 (inflation is 0.32%)

RI = real index 102,8/100,3 = 102,5

The real growth index is 102.5. This means that the real size of the Dutch economy increased by 2.5% in
2016 compared to 2015.

Correction for population growth

The population growth index in 2016 is 100.5 (PopI). To calculate the growth in disposable income, apply
the formula:

RIC / PopI * 100 = (102.5/100.5) * 100 = 102.0

This means that the disposable income in the Netherlands has risen by 2% per person*.

Subject to the condition that income is not transferred abroad.

Sources:

https://www.fhamers.nl/reeel-inkomen/

http://poliziek.info/bevolking-indexcijfer-bnp/

Example of a calculation:

In one country, total production in a given period is rising from 400 to 440 billion euros, inflation is 2 % and the
population of 10 million is growing by 500,000 people.

Questions:

1) What is the percentage increase in national production and what is the nominal index (NI)?

2) What is the price index (PI)?

3) What is the real increase in GDP and what is RI?

4) Is there an increase in disposable income in that country?

Answers:

1)

To calculate % change you use the formula (new - old)/old x 100%.

(440 400) / 400 x 100% = 10%

To get NI, add up the growth rate at 100 -> NI = 10+100 = 110

2)

definition of price index (PI) = % change + 100 = 2 + 100 = 102 = 102 = PI

3)

The formula applies here:

real index = nominal index/price index x 100 (short: RI = NI/ PI x 100). As the nominal (= expressed in cash income)
grew by 10 %, the value of NI 110/ RI = 110 / 102 x 102 x 100 = 107.8. Real GDP thus increased by 7.8%.

3 4)

in order to calculate disposable income (always per capita) you still need to filter the population growth from the
figure calculated above, because the increased number of people blurs the picture.

(10,5 10)/10 x 100% = 5%

the population index (PopI) = 105

107,8 / 105 x 100 = 102,7

Disposable income increases by 2.7%.

Additional assignment:

The following data are given for Vietnam:

2015 2016
GDP $ 193.2 bilion $ 202.6 billion
Inflation 0.9% 1.7%
Population 91,700,000 92,700,000
Source: https://atradius.nl/rapport/landenrapport-vietnam-2017.html

Assignement:

1. Calculate real economic growth in 2016 compared to 2015 in an index (2015 = 100)

2. Calculate the increase in average per capita income in 2016 compared to 2015.