Economic Growth

Last updated Jul 21, 2023 Edit Source

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• Economic Growth refers to an increase in the real output of goods and services in a country over time
  • Economic growth can be illustrated by an outward shift of the nation’s production possibility frontier (PPF) over time
• Growth is the most important macroeconomic objective
  • It determines the rate at which the economy expands to allow people to satisfy more wants in the future

• Even though economic growth increases material welfare, standards of living are an important consideration as a true measure of welfare
  • Economic growth does not necessarily mean true welfare is increases
• A sustainable rate of growth meets current needs without compromising the ability of future generations to meet their own needs
• Sustainable growth has many positive effects:
  • Growth rate can be maintained
  • Keeps inflationary pressures under control
  • Helps to maintain lower unemployment
  • Reduces pressure on resource use
• Sustainability is broken into four aspects: human, social, economic and environmental

• GDP is a measure of economic activity
  • It is the total value of all final goods and services produced in a year

Nominal and Real GDP

GDP is initially records the value of production in current prices. However prices can vary over a time period and thus the growth recorded may be a direct result of a price increase.

GDP measured this way is called nominal GDP. To compare GDP over different time periods, the price changes must be taken into account since GDP should be a measure of the value of production.

Real GDP adjust nominal GDP data to account for the shift in prices. Real GDP describes the value of output as if there had been no price changes in the economy.

• Real GDP per capita is the real GDP divided by the population of the economy
  • e.g. a country with a real GDP of $5 billion with a population of $1 million has a GDP per capita of $5000

• TBF

• TBF ( Link)

• Actual Growth vs Potential Growth
  • Actual Growth is the actual output of the economy
    • GDP = C + I + G + (X - M)
    • Determinants of actual growth involve components of aggregate demand or expenditure that influence GDP
      • These affect the demand side of the economy (aggregate expenditure)
  • Potential Growth refers to changes in quantity and/or quality of FOP
    • Its a measure of the capacity of the economy
    • Determinants of potential growth involve factors that influence the quantity and/or quality of factors of production
      • These affect the supply side of the economy
    • Increases in capital goods, labour force, technology, and human capital can all contribute to economic growth
      • These are known as ‘drivers of economic growth’
      • Human capital refers to employee skills and knowledge

• Allocating scarce funds to capital goods is known as real investment
• To achieve potential growth, more resources should go to producing capital goods over consumer goods
  • Standards of living (SOL) are reduced in the short run as resources are diverted away from private consumption
• However, increased investment in capital goods → greater output of consumer goods in the long run
  • SOL will increase in the future more than they would have if the economy had not made a short-term sacrifice
  • Economies face a choice between short-term vs long-term benefit

• Potential growth increases because new technology is inevitably more efficient than old technology
  • Production can increase because the new technology is more efficient
    • Output does not necessarily increase
• Actual growth increases due to investment
  • There is a transaction to buy the new technology which becomes a part of the GDP

• Depreciation will reduce an economy’s capacity
  • Machines will worsen and break over time
  • New workers need to be educated
• Investments in human and real capital need to compensate for depreciation
  • If investment does not happens, the PPF will slowly shift inward
• Human capital refers to work force
• Real capital refers to machines/technology

• Military conflict or national disasters can destroy factories, people, infrastructure, etc.

• Asymmetric growth is when economic growth occurs from increased productivity in one sector of the economy
• If an improvement in technology applied to the motor vehicle industry, but not to the food industry, the PPF curve would shift from one axis only
  • Example PPF: AsymetricalGrowth

• Economic growth incurs benefits and costs for people’s standard of living
  • Even though growth implies increasing levels of real income, therefore ability to satisfy more wants, there are costs brought with economic growth
    • Costs can be in the form of structural unemployment, inflation, environmental degradation and social dislocation
  • When we are talking about benefits and costs of economic growth, we are referring to actual growth

• Increase in real income (material welfare/standard of living)
  • Increased economic activity leads to greater income and expenditure
  • Increases in real income lead to more goods and services and better quality goods and services
• More economic opportunities
  • Increased GDP leads to greater production for goods and services
  • Firms have increased demand for labour to increase production
    • The increase in demand for labour lead to more economic opportunities for households
• Increase in taxation revenue → more merit and public goods
  • Since income for households and firms increase due to economic growth, governments get more money from taxation
    • Economic Growth → Greater Income → More Taxation
  • Governments have greater revenue to spend leading to an increase of merit and public goods available to society
    • Merit goods are goods/services that are under-consumed and thus are provided for free
      • e.g. healthcare, transport, education, etc.
    • Greater merit and public goods leads to increases in SoL
• Higher quality goods and services
  • Since people’s incomes are increasing leading to an increase in their purchasing power, they are more willing to buy more and/or better goods and services

• Uneven growth → widening income gap
  • Not everyone may experience an increase in standard of living
  • People don’t receive the benefits of economic growth or receive only minimal benefits
  • Growth can widen the distribution of income because some groups may benefit much more than others
  • This can cause dissatisfaction and divide people from different classes
• Associated with a structural change in economy (+/-)
  • Economies can have either a positive or negative structural change
  • e.g. an economy may be based heavily around typewriters and economic growth in the computer sector leads to a shrink in the typewriter sector, it will have a big impact on the economy as it changes the structure of the economy leading to loss of jobs.
    • A fall in demand can lead to structural unemployment
• Inflationary pressure (demand pull)
  • Inflation caused by rising aggregate demand
    • Rising aggregate demand in the economy results in shortages which causes the price to increase
  • This occurs because aggregate supply does not increase as fast as aggregate demand
    • If aggregate supply increased at the same rate of aggregate demand, there would not be inflation, however this is not the case
• Social Costs
  • e.g. crime, suicide due to stress, etc.
  • Link between high levels of income and crime
    • Usually theft
  • Difficult to explain (you must link with an economic effect)
• Associated with economic ‘bads’ as well as ‘goods’
  • Increase in the effect of negative externalities are there is an increase in the production/consumption in industries where these externalities are present
  • Environmental problems
    • e.g. pollution, congestion (negative externalities)
• Falling Savings
  • People have greater incomes leading to greater purchasing power leading to greater consumption
  • This means that spending increases and saving decreases
    • However this depends on what bracket of income someone is in
    • People with high incomes do not have as large of a decrease in savings as those with lower incomes
  • Falling savings can lead to people falling into debt
• Inflation and balance of payments difficulties
  • Too rapid a rate of growth can also lead to Inflationary pressure and a balance of payments deficit
  • This is because imports rise to satisfy an increasingly active household sector