The Measure of Economic Health
ECO203: Principles of Macroeconomics
Professor
September 28, 2020
The Measure of Economic Health
To determine the best policies that will lead to the economy’s growth, governments follow a set of indicators such as employment, inflation, present and future output, and economic conditions. However, the most common method of determining how healthy the economy is computing the gross domestic product (GDP). GDP is defined as the market value of goods and services produced by the economy in s given year (Picardo, 2016). It consists of goods and services produced in a country, and it excludes those made outside. It also excludes intermediate products and only considers goods produced for the final user. Therefore, it is crucial that one understands the measures used to determine the health of an economy and understand where the economy is heading. This paper will evaluate the importance of GDP as a measure of economic health by examining its shortcomings, how it can be used to assess the business cycle, factors affecting the business cycle, and the US economy’s current health.
Importance of GDP
GDP is essential as it helps to identify how the economy is performing and its size. The general health of an economy can be determined by measuring the growth rate of real GDP. The economy is doing well if the real GDP is increasing. A high GDP implies an increase in the average income, and more employment opportunities are created (Picardo, 2016). The GDP also reduces the borrowing rate of the government as it produces higher tax revenues. Gross Domestic Product (GDP) calculates the economic status of any country. GPD conveys the monetary value of a nation’s finished goods and services within the respected country. GDP monitors various sectors within the economy, such as the Household Sector, Business Sector, Government Sector, and Foreign Sector.
Shortcomings of GDP in Measuring a Country’s Economic Health
Although GDP is the most common indicator of a country’s economic health, it has some shortcomings that limit its use. The first shortcoming is that it does not take into account the underground economy. Underground economy refers to transactions that are not recorded and which are often considered as the illegal supply of goods and services (Ivković, 2016). It includes weapons, drugs, prostitution, among other forms of unlawful trades. The underground economy forms a significant part of a country’s economic output. Due to its illegal nature, it is hard to keep formal records of the underground economy.
The second shortcoming is that it promotes environmental abuse. For companies to gain more output, they increase their production with little regard for how it may impact the environment (Ivković, 2016). Developed countries have environmental laws that penalize companies that pollute the environment. Developing countries are less concerned about the impact that high output may have on the environment. However, environmental pollution should be counted against a country’s GDP as it is not sustainable. Another shortcoming is that it does not take into consideration non-market production. Non-market production refers to goods and services with no official records of output as they are mostly produced for private consumption (Ivković, 2016). For example, people who make their own electricity or grow their own food.
Using GDP to Evaluate the Business Cycle
The economy of each country fluctuates between times of contraction and expansion. The changes are triggered by demand and supply of goods and services produced by a state and employment levels. The business cycle refers to the increase and decreases in the GDP of a country over time. In a growing economy, the business cycle shows a gradual increase in potential output. GDP can be used to evaluate business cycles. During the economic contraction cycle, the GDP is low due to decreased demand and supply of products and services. Companies do not make enough revenue and begin to lay off employees. During this phase, the GDP is positive.
The economic trough comes after the contraction. It implies that the economy is heading to recession due to high unemployment rates and low economic output. The GDP is negative, suggesting that there is no growth at all. Economic expansion is the next business cycle, and it marks the recovery of the economy. An increase in GDP shows there is monetary expansion. It is characterized by the growth of the economy in three consecutive calendar quarters (Huo et al., 2019). The highest point of economic growth is the financial peak, and it is a result of an increase in GDP. However, it is considered an adverse economic event as it shows that the economy is heading to a contraction despite the rise in GDP.
Factors That May Affect the Business Cycle
Several factors affect the business cycle as it relates to the economic growth volatility in different periods of the economy. The first factor affecting the business cycle is interest rates. Interest rates directly affect how consumers spend their money, which in turn affects economic growth. If the interest rates are dropped, consumers’ disposable income increases as it reduces the borrowing cost (Berger et al., 2020). It leads to higher spending and hence the growth in the economy. Marketing is the second factor that affects business cycles. Marketing informs consumers of the presence of a product. There is also a need to ensure that the products are in line with the consumers’ needs.
The third factor is competition. When a product enters an existing market, it has to distinguish itself from the already available products. To be successful, it offers more appealing features of reduced prices. It impacts how consumers spend their money. The fourth factor is time. Business cycles can last for months, while others can last for decades. However, there are fluctuations in the growth of GDP in these periods. Some products can grow then decline while others decline, after which they grow without reaching maturity (Berger et al., 2020). It, in turn, affects the business cycle of the product.
The Health of the Current U.S. Economy by its GDP, Business Cycle, and Economic Growth
The United States economy is in decline following the Covid-19 pandemic. The economy growth reduced by 5% in the first quarter of 2020, which marked the beginning of the recession (Berger et al., 2020). In the second quarter, it declined by 31.7% (Berger et al., 2020). It is predicted that it will rise in the third quarter although earlier losses may not be recovered. The closer of non-essential businesses led to a decline in retail sales by 16.4%, and unemployment levels increased to 23 million people (Berger et al., 2020). However, there was an increase in the sale of foods since July. The economic growth is expected to reduce by 3.7% in 2020, but it may grow by up to 4% in 2021 (Berger et al., 2020).
Conclusion
Economic health is essential and economic indicators are used by governments, investors, and businesses to determine how well the economy is doing. GDP is among the indicators used to measure the health of the economy. An increase in GDP implies that there is growth in the economy and is also used to determine the size of the economy. However, several shortcomings limit the use of GDP as a measure of a country’s economic health. Failure to include the underground economy and how production affects the environment makes GDP unreliable. Various factors that affect the business cycle include competition, finances, and marketing.
References
Berger, T., Richter, J., & Wong, B. (2020). Financial factors and the business cycle.
Huo, Z., Levchenko, A. A., & Pandalai-Nayar, N. (2019). The global business cycle: Measurement and transmission (No. w25978). National Bureau of Economic Research.
Ivković, A. F. (2016). Limitations of the GDP as a measure of progress and well-being. Ekonomski Vjesnik/Econviews-Review of Contemporary Business, Entrepreneurship, and Economic Issues, 29(1), 257-272.
Picardo, E. (2016). The GDP and its importance.