1. Definitions
→ Economic growth → an increase in the real output of goods and services produced by an economy over time
→ Real GDP → the value of goods and services produced in an economy measured at constant prices → removes the effect of inflation
→ Nominal GDP → the value of goods and services produced in an economy measured at current prices → affected by both changes in output and changes in prices
→ GDP per capita → real or nominal GDP divided by the population → measures average output per person
→ Actual economic growth → an increase in the economy’s actual real output → usually measured by an increase in real GDP
→ Potential economic growth → an increase in the productive capacity of an economy → shown by an increase in LRAS
→ Sustainable economic growth → economic growth that can continue over time without causing serious economic, social or environmental problems
2. Core Concepts
Meaning of Economic Growth
→ Economic growth → increase in real GDP over time → economy produces more goods and services
→ Increase in real GDP → higher level of economic activity → firms increase production → demand for labour may increase → employment rises
→ Economic growth can be divided into:
→ Short-run/actual growth → movement towards existing productive capacity → usually caused by an increase in AD
→ Long-run/potential growth → increase in productive capacity → LRAS shifts right
Measurement of Economic Growth
→ Economic growth is primarily measured using the percentage change in real GDP
→ Economic growth rate = [(Real GDP in current year − Real GDP in previous year) ÷ Real GDP in previous year] × 100
→ Example → real GDP increases from $500 billion to $520 billion
→ Increase in real GDP = $20 billion → economic growth = 4%
→ GDP per capita can also be used → GDP ÷ population → gives an indication of average output per person
→ GDP per capita is useful when comparing living standards between countries or over time → population growth may otherwise make total GDP misleading
Nominal GDP vs Real GDP
→ Nominal GDP → calculated using current prices → increase may occur because prices have risen rather than because more goods and services have been produced
→ Real GDP → adjusted for price changes → provides a better measure of changes in actual production
→ Inflation increases → nominal GDP may increase even when real output remains unchanged
→ Therefore → real GDP is preferred when measuring economic growth
→ Example → nominal GDP rises by 8% while inflation is 5% → real GDP growth is approximately 3%
3. Diagrams
AD/AS Diagram Showing Actual Economic Growth
→ Vertical axis → Price Level
→ Horizontal axis → Real Output
→ AD shifts right → equilibrium real output increases → actual economic growth occurs
→ If the economy initially has spare capacity → increase in AD can produce a relatively large increase in real output with limited inflation
LRAS Diagram Showing Potential Economic Growth
→ LRAS shifts right → productive capacity increases → economy can produce a higher level of potential output
→ Causes of rightward LRAS shift → improved technology → increased capital → improved education and training → larger skilled workforce → better infrastructure
→ Increase in LRAS → potential economic growth → allows higher output without necessarily creating the same inflationary pressure as an AD increase
Production Possibility Curve
→ PPC shifts outward → economy’s productive capacity increases → potential economic growth
→ PPC shifts outward because → resources increase → productivity improves → technology improves → quality of factors of production increases
4. Examples
→ Investment in infrastructure → better roads, ports and electricity networks → firms become more productive → productive capacity increases → economic growth
→ Improved education and training → human capital increases → labour productivity increases → firms can produce more → LRAS increases → potential growth
→ Technological development → production becomes more efficient → unit costs may fall → firms can produce greater output → economic growth
→ Increase in consumer confidence → consumption increases → AD increases → firms increase production → actual economic growth
→ Increase in exports → net exports increase → AD increases → domestic firms expand production → actual GDP increases
5. Analysis
Causes of Economic Growth
→ Increase in consumption → C increases → AD increases → firms receive more orders → production increases → real GDP increases → actual economic growth
→ Increase in investment → I increases → AD increases → firms increase production → real GDP increases
→ Investment also increases the capital stock → productive capacity increases → LRAS shifts right → potential economic growth
→ Increase in government expenditure → G increases → AD increases → firms expand output → employment increases → actual economic growth
→ Increase in exports → X increases → net exports increase → AD increases → domestic production increases → real GDP rises
→ Improved productivity → more output produced from existing resources → production costs may fall → productive capacity increases → LRAS shifts right → potential economic growth
→ Technological progress → productivity increases → firms can produce more efficiently → productive capacity increases → long-run economic growth
→ Increase in labour supply → more workers available → potential output increases → LRAS shifts right → economic growth
→ Improved human capital → education and training increase worker skills → productivity increases → productive capacity increases → potential growth
→ Increase in capital stock → firms have more machinery and equipment → workers can produce more output → LRAS increases → potential growth
→ Supply-side policies → incentives to work, invest and innovate → productivity and productive capacity increase → LRAS shifts right → long-run economic growth
Consequences of Economic Growth
→ Economic growth → real GDP increases → firms produce more → demand for labour may increase → employment increases → unemployment falls
→ Economic growth → household incomes may increase → consumption increases → material living standards may improve
→ Higher incomes → government receives more tax revenue → government may have greater ability to provide public services
→ Economic growth → firms may earn higher profits → investment may increase → further increases in productive capacity
→ Higher output → government tax revenues may increase → budget deficit may decrease → depending on government spending and tax policies
→ Economic growth can improve living standards → but GDP growth does not automatically mean everyone becomes better off
6. Evaluation
→ Short run vs long run → AD-driven growth can increase actual output in the short run → but sustained long-run growth requires increases in productive capacity
→ Spare capacity → if the economy has substantial spare capacity → increase in AD can produce strong growth with limited inflation → if the economy is close to full capacity → additional AD is more likely to cause inflation
→ Inflation → rapid AD-driven growth → excessive demand pressure → price level rises → purchasing power may fall → growth may become unsustainable
→ Unemployment → economic growth usually increases employment → but if growth results mainly from automation or productivity improvements → employment may increase less than expected
→ Income distribution → economic growth increases average income → but gains may be unevenly distributed → inequality may increase
→ Environmental effects → higher production and consumption → greater use of energy and natural resources → pollution and environmental damage may increase
→ Current account → strong economic growth → higher household incomes → imports may increase → current account deficit may worsen
→ Quality of growth → growth based on productivity, technology and investment is generally more sustainable → growth based mainly on excessive consumption may create inflation and external imbalances
→ Population growth → total real GDP may increase while GDP per capita falls → therefore GDP per capita is often more informative when assessing changes in average material living standards
→ Development level → developing economies may gain substantial benefits from growth through higher employment, incomes and access to goods and services → however, environmental and inequality effects may become significant
→ Judgement → economic growth is generally beneficial when it is sustainable, productivity-driven and widely distributed → the overall impact depends on the source of growth, spare capacity, inflation, income distribution, environmental consequences and the time period considered
7. Exam Tip
→ Always distinguish actual growth from potential growth → actual growth is usually linked to AD increasing → potential growth is linked to LRAS increasing
→ When explaining a cause of growth → use a chain → cause → AD/LRAS → real output → employment/income → economic growth
→ When evaluating the consequences → do not automatically assume growth is beneficial → consider inflation, unemployment, inequality, current account and environmental sustainability → then give a reasoned judgement