Thursday, July 28, 2011

How To Calculate Economic Growth

We are not talking about average growth rates here. Nope we are instead looking at how to compute growth rate in any one period given the structure of the economy in the preceding period. And to make our point fun we're considering three cases. 

First, an economy with only one sector. Piece of cake: the growth rate of the economy is equal to the growth rate of the sector. 

Next an economy with 2 equal sectors. Here we just need to calculate the average of the growth rates of the two sectors to get the growth rate of the economy. 

But if we have 2 unequal sectors  -- as illustrated in the rightmost part of our chart -- we need to do the weighted average growth of the two sectors. For instance if the biggest sector is 4 times the smaller one and they grew by 5% and 10% respectively then the growth rate of the economy would turn out to be 4/5x5%+1/5x10%=6%. Naturally if the two unequal sectors grow at the same rate so will the economy. 

This explanation will become quite handy to discuss a number of interesting things. So stay tuned!

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