Factors Influencing Gross Domestic Product

Elements Affecting GDP

Consumption

An increase in consumption will cause GDP to increase. This means there is an increase in living standards as more people can consume higher levels of goods and services. Income has a positive relation with consumption. An increase of consumption will immediately push up imports. An increase of domestic consumption might decrease exports, since at the same level of production, firms would prefer to sell inside the country.

Investment

GDP increases when businesses invest money in infrastructure, real estate, and other physical operations. Financial investment can also have an impact on other GDP factors, such as consumer spending, by creating jobs and creating buying power for consumers. Without investment, an economy could enjoy high levels of consumption, but this creates an unbalanced economy. There will tend to be a current account deficit. Industries whose businesses tend to invest more of their profits tend to grow and comprise a larger percentage of GDP.

Government Spending

It is possible that increased spending and a rise in taxes increases GDP. Increased GDP per capita will improve government finances. This is because people will pay more income tax and more VAT; firms will pay more corporation tax. Also, the government will spend less on income support and unemployment benefits. Therefore, the budget deficit will decrease. Also, the government could decide to spend more on investing in the economy, e.g. spending on better roads. This will enable higher rates of growth in the long term.

Unemployment

Affects consumption and investment. An increase in unemployment will cause consumption to decrease. If this situation persists for several months, there will be a standstill of GDP: sales will decrease, unemployment will increase, and companies’ income will decrease.

Productivity

Productivity falls because of low levels of investment and falling real wages. Higher productivity can lead to:

• Higher wages (as workers are more efficient)
• Lower unit costs and higher profits

Monetary Policy

Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency.

Expansionary Monetary Policy

Expansionary monetary policy is when a central bank uses its tools to stimulate the economy. That increases the monetary supply, lowers interest rates, and increases aggregate demand. That boosts growth as measured by gross domestic product.

With an expansionary monetary policy, it is expected that domestic GDP will increase. This will tend to increase imports. The increase in imports will cause the current account (CA) to deteriorate.

This policy involves cutting interest rates; it will tend to increase overall demand in the economy.

• Lower interest rates make it cheaper to borrow; this encourages companies to invest and consumers to spend.
• Lower interest rates reduce the cost of mortgages. This gives households greater disposable income and encourages spending.
• Lower interest rates reduce the value of the pound, making exports cheaper and increasing export demand.

In theory, this policy should cause higher economic growth and lower unemployment.