Dr. Mercy Otieno, Ph.D. Economics and Finance
© International Foundation for World Freedom
Gross Domestic Product (GDP)
A country’s GDP measures the final value of all goods and services produced within that country’s borders in a given time period. While most countries report their GDP on an annual basis, others report GDP on a quarterly basis. Economists and news outlets will often talk about GDP growth, which is the change in a country’s GDP across time periods, expressed as a percentage. If that percentage is positive, then GDP grew across the time periods; if it is negative, then GDP shrunk across the time periods. You may hear of “slowing GDP growth” – this indicates that the percentage growth is still positive, it is just a smaller positive. Similarly, accelerating growth just means that a positive percentage growth rate has gotten even larger. Currently the GDP for the US and most economies is growing as productivity returns to normal.
While GDP can be a useful measure of economic activity, especially when compared over time for a given country, it has many limitations. The following are some of the most important limitations of GDP:
It excludes the value of economic activities that are not officially monitored by the government, and therefore not included in GDP. These activities can include such things as babysitting, lawn-mowing, household maintenance, housecleaning, and even illegal drug sales. Some countries have higher levels of these kinds of non-market activities than others, making cross-country comparisons somewhat less straightforward.
It excludes the values of public stocks of goods such as open space, clean water, clean air, healthy forests with intact ecosystems and high levels of biodiversity, etc. Suppose a country increased the value of its factory-produced goods by $1 billion, but in doing so, it polluted all its waterways and bodies of water. If nothing else in the economy changed (i.e., all other industries and sectors maintained the same levels of output), this country’s GDP would increase by $1 billion – with nothing to reflect that the GDP increased at a steep cost to the country’s clean water resources. The loss of clean water resources is a cost (a negative externality) to society that is not included in the equations used to measure GDP. Other costs that are not included in the measurement of GDP include things like deteriorating human health or human rights.
Total GDP does not account for population size nor the evenness of the distribution of GDP among the population. For example, suppose Country A has a GDP of $3 trillion, while Country B has a GDP of $2 trillion. With just that information, you might reasonably conclude that Country A is “richer” than Country B. However, suppose that Country A has a population of 200 million, while the population of Country B is 50 million. The GDP per capita of Country A is therefore $15,000 while the GDP per capita of Country B is $40,000! Viewed on a per capita basis, you could now reasonably conclude that Country B is richer! While GDP per capita is certainly a more informative way to use GDP information, it assumes that GDP is spread evenly among all residents of a country, which clearly does not reflect reality. The more unevenly GDP is spread among a country’s population, the less useful GDP per capita reflects the real economic state of things in a country.
Alternative indicators have been developed by different national and international organization to provide a more well-rounded measure of a nation’s quality of life these include the Human Development Index (HDI), the Genuine Progress Indicator (GPI), and the Happy Planet Index (HPI). Each of these indexes is a composite measure weighing both income and non-income variables such as life expectancy, literacy rates, environmental indicators, measures of inequality among others.
Unemployment Rate
The labor force includes all people aged 16 and older who are classified as either employed or unemployed. Thus, the labor force is the number of people who are either working or actively looking for work. A person is considered unemployed if he or she willing and able to work and are seeking employment but have not yet found suitable employment. There are multiple measures of unemployment rates, but the most straightforward is simply the number of unemployed persons as a proportion of the labor force. While not given as much attention as unemployment, a related concept is that of underemployment,whereby a person is employed but isworking forfewer hoursthan desired or in a position for which he orshe is overqualified and not making as much use of his or herskills as he or she would desire. There is always some unemployment in every economy, with an unemployment rate of about 3%- 5% considered the “natural rate of unemployment”. In 2022 the US has been experiencing lower unemployment rates (similar to pre-COVID levels) implying an increase in economic activity. According to Bureau of Economic Analysis, the unemployment rate declined to 3.5 percent, labor force participation was 62.3 percent, and nominal wages rose by 0.3 percent in September. The increase in jobs was mostly in education, healthcare and the private sector as a whole. However, as the economy nears full employment, the economic growth will start to decline.
Inflation Rate
The prices of goods and services change over time due to a variety of factors, including costs of production, consumerdemand,trade agreements, governmentintervention, andmore.Theprices for most goods increase over time, while the price for some goods tend to decrease over time (many technological devices and apparatuses fall into this category), and still others fluctuate move sporadically,rising and falling depending ontheyear and time ofyear(agricultural goods and metals are frequent examples). An overall state of rising prices is called inflation, whereas the opposite is called deflation. The overall percentage change in the pricesfor a composite “basket” of goodsis called the inflation rate. One of the tasks of the U.S. Federal Reserve (the Fed) is to keep the U.S. inflation rate around 2%-3%. Very highinflation ratesmake goods andservicesless affordable andmake the dollar worth less because one cannot buy the same amount of goods and services with a dollar than before. Deflation is also undesirable because it is general an indication that an economy that is not growing. The Fed has several tools it can use to affect inflation rates. This set of tools can broadly be called “monetary policy”. The U.S. is currently experiencing a period of relatively higher inflation than what the experts predicted in 2021 (see graph below). While the price of gasoline has reduced nationwide, there is a surge in the prices of groceries and food compared to 2021. The high rates are attributed to high consumer demands and global shortage of products due to the pandemic supply disruptions among other factors. The high rate of price increase is expected to hold until March 2023 when the Fed meets to revise the interest rates. The current high inflation can now be considered “persistent” inflation as opposed to “transitory”. Note that “persistent” suggest that the monthly inflation rate has been high for a prolonged period and is expected to continue rising exceeding the interest rate.
Interest Rates
The cost of borrowing money is called the interest rate. The rate you pay to borrow money depends on many things, including your credit rating, what you intend to use the loan for, and the term, or length of your loan. The US Federal Reserve influences interest rates though the implementation of “Monetary policy”. Monetary Policy is used primarily as a tool to effect inflation and the unemployment rate. If the inflation rate is low and unemployment high, the Fed implements monetary policy to encourage rates to move lower. Lower interest rates make it cheaper for ordinary people to borrow money to buy a house or buy more goods on credit. If ordinary people are purchasing more, this will increase demand on businesses that sell those things. Increased demand on business should lead to hiring more people to make, distribute or sell their goods. Lower inters rates also encourage business to borrow and invest to increase production. The Fed has been hiking the interest rate in 2022 as seen in the graph below. The aim is to slow down the economy and ensure lower spending on goods and servicesfor households and businesses. This decision to increase interest rates might lead to high prices in buying a car, house and borrowing through credit cards. In the graph below we can see a sharp rise in interest rate from the beginning of 2022.
