With the election drawing nearer (although, to be honest, it feels like it’s been going on for an eternity now) it’s probably a good idea to brush up on some basic economic terms and principles. This week we’ll be launching a short series on the topic to help you better navigate the vast amount of information that may be coming at you from various media sources particularly as it may pertain to the future of the financial markets. We’ll start off with a simple look at the very basics of our economy and what causes it to grow. Possibly the most common term you’ll hear when people talk about the economy is GDP. GDP stands for Gross Domestic Product and is basically the monetary value of all of the goods and services produced within a country’s borders during a specific period of time. This is in contrast to GNP which stand for Gross National Product and is the monetary value of goods and services produced by a country’s citizens (meaning that the U.S. GNP number would include services produced by a U.S. citizen living in France while the GDP number would not).
A very basic formula of economic growth looks something like this:
Economic Growth = Growth in Labor + Growth in Capital Investment + Technological Advancement
What this means in layman’s terms is that our economy grows when:
The Labor Force grows (ie more people work)
The amount of labor increases (ie people work longer hours)
We invest monetarily in businesses which allow them to purchase machinery and increase their production
We make technological progress which also allows companies to increase their productivity (consider how much more work we can now do with the invention of the internet)
These are all variables that economists look at when they’re trying to determine the health of an economy. When you read articles about an aging workforce you can infer that this would result in a slowdown in labor because people are retiring, which results in a decrease in the labor force. All things equal, this would lead to a slowdown in economic growth because the first term in our equation would be negative. In regards to growth in capital investment, we can see growth increase and decrease based on increases and decreases in the market. Often, when there’s a slowdown, investors get spooked and pull their money out of the market. This not only drops the price of the stock, but it also leaves the individual company (or companies) with less capital with which to grow. Looking back historically, we can also see different points in time where various inventions such as the wheel, the cotton gin, the steamboat, and the computer (to name a few) have greatly increased our productivity and allowed the economy to grow. These are just of few examples of how economic growth is affected by what’s going on in the world.
While economics is certainly a complicated field, it’s helpful to have a basic idea of how our economy works particularly when it comes to making decisions that have the potential to inform policy. In the coming weeks, we’ll discuss not only the basics of a single economy, but also the basics of how different countries' economies interact on a global basis to help you have a better grasp of the implications of different decisions that our policy makers make.