0
$\begingroup$

How does the world GDP increase? The world GDP tends to increase on average every year (exception being years of global recession). If in year x the world GDP was 100 million dollars, how can the world GDP in year x+1 be, let's say, 105 million dollars? This would mean that 5 million dollars were printed. Am I correct to assume that the increase in GDP is exclusively caused by inflation? Otherwise, how (even if much more goods and services were produced) would the world GDP increase if the money supply remained constant?

$\endgroup$
5
$\begingroup$

Am I correct to assume that the increase in GDP is exclusively caused by inflation?

No.

World GDP increases when the world produces more in one year than it did the year before. Inflation means (among other things) that prices increase.

Suppose this year the world produces 10 apples valued at two dollars each. Suppose next year the world produces 11 apples still at two dollars each. In that case, real and nominal GDP growth is 10%.

If the price of apples increases, then nominal GDP growth will be more than 10%, but real GDP growth, which filters out price fluctuations, will still be 10%.

$\endgroup$
4
  • $\begingroup$ But, by the formula GDP=C+I+G+(X-M) the money supply would have to increase in order for at least one of the components to increase. So if there is a 50 million dollar money supply, how can one of the components increase its value? $\endgroup$ – vb2019 Feb 4 '20 at 22:24
  • 3
    $\begingroup$ @vb2019 the equation you have given is an accounting identity. What that means is it is not a mathematical formula - it is, in essence, a statement that "The thing on the left of the equals sign must match the thing on the right of the equal sign". The extra apple would show up as an increase to C. Separate to this issue is whether enough money supply exists to support all of the transactions that result in GDP - it may or may not be the case that money supply would increase in the year that GDP increases. Another accounting identity, the "quantity theory of money", can shed light on that. $\endgroup$ – heh Feb 4 '20 at 22:53
  • 1
    $\begingroup$ @vb2019 to expand on heh (+1) comment. Real GDP - which is what we care in economics about in long term does not depend on money supply. For example let’s imagine money supply is fixed at 2e and in year t one apple is produced and consumed and in year t+1 2 apples. Purpose of money is just to buy all products in economy so in the first case price will be 2e per apple and in second case 1e per apple. Nominal GDP will be in both cases 2e but real GDP that can be calculated by adjusting for the price change will be 2/(1/2)=4. So GDP doubled because production doubled. The deflator was 1/2... $\endgroup$ – 1muflon1 Feb 5 '20 at 0:00
  • 1
    $\begingroup$ Because prices decreased by half. Generally the quantity theory of money says the following will be true MV=PY or in plain English money supply (M) times velocity of money V must be equal to price level P times real output (GDP) Y. Even if M is completely fixed the real GDP can increase - either prices or velocity of the money can adjust (usually it will be prices because velocity is more or less constant). $\endgroup$ – 1muflon1 Feb 5 '20 at 0:05

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.