Economic Growth PDF

# Economic Growth ## What is Economic Growth? One of society's prime responsibilities is to provide a reasonable standard of living for its citizens and to promote their well-being. Economic growth is a major objective for economic policy in the long run to enable improvements in well-being. **K...

# Economic Growth ## What is Economic Growth? One of society's prime responsibilities is to provide a reasonable standard of living for its citizens and to promote their well-being. Economic growth is a major objective for economic policy in the long run to enable improvements in well-being. **Key Terms:** * **Potential Economic Growth:** An expansion in the productive capacity of the economy. * **Actual Economic Growth:** The rate of growth of real GDP in a period. * **Output Gap:** The difference between actual real GDP and potential real GDP. * **Investment:** Expenditure undertaken by firms on capital goods. * **Productivity:** A measure of the efficiency of a factor of production. * **Labour Productivity:** A measure of output per worker, or output per hour worked. * **Capital Productivity:** A measure of output per unit of capital. * **Total Factor Productivity:** The average productivity of all factors, measured as the total output divided by the total amount of inputs used. * **Human Capital:** The stock of skills and expertise that contribute to a worker's productivity; it can be increased through education and training. * **Export-Led Growth:** A strategy for achieving rapid economic growth through the promotion of export activity. ## Defining Economic Growth From a theoretical point of view, **potential economic growth** can be thought of as an expansion of the productive capacity of an economy. **Actual economic growth** (measured by the rate of growth of real GDP) may also reflect a movement towards the frontier, for example, when an economy is recovering from a period of recession. **Study Tip:** Be aware of the distinction between the level of real GDP and the rate of economic growth. The actual rate of growth is calculated as the percentage change in the level of real GDP. ## Sources of Economic Growth Two basic sources of economic growth stem from the use of factors of production: capital, labour, enterprise, and land. Capacity output is reached when all factors of production are fully and efficiently utilised. An increase in capacity output can come from an increase in the *quantity* of the factors of production, or from an *improvement* in their efficiency or productivity. **Capital** is a critical factor in the production process. An increase in capital input is thus one source of economic growth. In order for capital to accumulate and increase the capacity of the economy to produce, investment needs to take place. **Labour** has sometimes been seen as the main driver of growth, but labour too has a key contribution to make. There is little point in installing a lot of high-tech equipment unless there is the skilled labour to operate it. **Growth and international trade** International trade can contribute to economic growth. Indeed, for many relatively small countries, international trade is a key part of achieving economic growth. **Growth and aggregate demand** An increase in aggregate demand can lead to higher real output in the economy if the initial equilibrium is below full capacity output, but this is equivalent to a move towards the PPF. In other words, this is actual economic growth that does not affect overall productive capacity in the economy. ## Summary: Economic Growth Economic growth is the expansion of an economy's productive capacity. This can be envisioned as a movement outwards of the production possibility frontier, or as a rightward shift of the aggregate supply curve. Economic growth can stem from an increase in the inputs of factors of production, or from an improvement in their productivity: that is, the efficiency with which factors of production are utilised. **Exercises:** 1. **What is the difference between actual and potential growth?** 2. **How would you show a fall in an economy's potential capacity output in an AD/AS diagram?** 3. **Explain why it is difficult to identify potential economic growth.** 4. **If an economy is operating with output below its full capacity output, would there be a positive, or negative output gap?** 5. **Name the two key ways in which the productive capacity of an economy can increase.** 6. **What is the difference between gross and net investment?** 7. **China's economic growth has been enabled by high investment and exports. What is the opportunity cost of this?**