ECONOMIC GROWTH

Source: IB Economics: A Course Companion. (Blink & Dorton, 2011)

p244-249

Macroeconomic Objectives:Economic Growth

• Economic growth can help achieve two other important economic objectives: low unemployment and low and stable rate of inflation.

Rates of Economic Growth

• Rates of economic growth vary over time and from country to country.

• As we know, economies face periodic fluctuations in economic activity and growth rates, known as the business cycle.

Using Diagrams to Illustrate Growth

• It may be argued that demand side factors can bring about short-term economic growth.

• We can illustrate this using a combination of an AD / AS model with a PPC model.

Consider an economy which is operating with a deflationary gap as shown above. This would be the equivalent to the economy operating at point “a” within the PPC. In this case the economies resources are not being used to the fullest extent possible. That is, there is underemployment or unemployment of resources or factors of production.

If there were to be an increase in aggregate demand from AD1 to AD2 then the deflationary gap could be removed and there would be an increase in real output from Y1 to Y2 = Yf. This would be the equivalent to the movement from “a” to “b”. The increase in real output is an increase in real GDP, so there has been economic growth.

The Increase in Real Output improves resource utilization

• The increase in aggregate demand has brought about the need to use those underemployed or unemployed resources, moving the economy towards the full employment of resources.

• In this case economic growth comes about by increasing the employment of the factors of production.

Points Near & On the Production Possibility Curve (PPC)

• You will see that in the previous graphs, point b Is not on the PPC, but just short of it.

• This is because an economy will never fully employ all resources to the fullest extent possible. Eg: There will always be some unemployment in the form of natural unemployment.

• This is why the LRAS curve is not exactly the same as the PPC in terms of representing potential output.

Long Term Economic Growth

Economic growth can occur in the long term as a result of increasing the full employment level of output or potential output. In this case, there is an increase in the GDP figure as a result of a shift in the LRAS curve. The equivalent change in shown as an outward shift in the PPC. This comes about because of improvements in productivity and advances in technology – the supply side. It will be achieved through market forces or government supply side policies – either interventionist or market based.

Positive Consequences of Economic Growth

• It may be assumed that, on the whole, in the absence of periodic recessions, aggregate demand tends to increase steadily as population size and income grow.

• Without supply side improvements to shift out the LRAS, aggregate demand would increase more than aggregate supply and there would be inflation.

Non-Inflationary Economic GrowthWhen economic growth is supported by an outward movement of the aggregate supply curve, economies can experience non-inflationary growth. The movement from AD1 to AD2 indicates “normal” increases in aggregate demand due to growing populations and rising incomes. As long as the economy also makes improvements on the supply side to shift out the LRAS, then GDP will increase without any upward pressure on the price level a to b. The movement from Y1 to Y2 represents non inflationary growth.

Non Inflationary Economic Growth

• Supply side policies and the growth they support result in lower unemployment and downward pressure on the price level.

Economic Growth & Higher Living Standards

• Since economic growth is an increase in national output this is an equivalent to increase in national income.

• If GDP per capita also increases, which depends on population growth, then the income of the average person will increase.

• It will be normal to assume that this may be equated with higher living standards.

• If you compare your living standards with those of your parents and grandparents when they were your age, you are likely to see many ways in which your material level standards have improved.

Economic Growth & Technology

• Economic growth has not only been achieved by great leaps in technology, but has contributed to great leaps in technology, leading to advancements in areas such as medicine, household appliances, computers, audio-visual equipment, transportation and entertainment to name a few.

• Such advancement have the possibility of making life easier and more pleasurable, contributing to higher living standards.

Economic Growth & Taxation Revenue

• Depending on the nature of a country’s tax system, higher incomes are likely to lead to greater tax revenues, and this may make it possible for a government to spend more on merit goods and public goods, thereby further improving living standards.

• Tax systems can also redistribute income and reduce income inequalities.

Economic Growth & International Competitiveness

• Economic growth that comes about as a result of higher productivity may also bring about an improvement in the competitiveness of a country’s exports, leading to further increases in aggregate demand.

• However, it must also be recognized that higher national income also increases the demand for imports, so the final impact on net exports will depend on many factors.

Economic GrowthEducation & Democracy

• There is a compelling argument, that as national income rises, so do the levels of education and human capital and greater demands for freedoms and democracy.

Book: The Moral Consequences of Economic Growth (Benjamin Friedman)

• “Our conventional thinking about economic growth fails to reflect the breadth of what growth, or its absence, means for a society.

• “Growth is valuable, not only for material improvements, but also for how it affects our social attitudes and our political institutions, in other words, our society’s moral character.

Negative Consequences of Economic Growth

• An increase in incomes is not necessarily the equivalent to an increase in happiness, and one should question the notion that an increase income automatically leads to an increase in living standards.

Higher Incomes may means less leisure time!

• High income may come about by sacrificing leisure time and neglect of personal relationships, which would not mean better living standards.

• It might also be that the more people earn the more goods and services they want and are therefore never satisfied.

• The resulting preoccupation with greater and greater material wants might make people less happy.

Economic Growth & Structural Unemployment

• Economic growth involves a structural change in an economy. • Typically, economies move from having a larger share of

output being generated from the primary sector, to a larger share being generated from the tertiary sector.

• Even within the sectors, there will be changes as a result of economic growth.

• As these structural changes within an economy occur, the adjustments are likely to result in structural unemployment.

• Not everyone benefits from the economic growth to the same extent an inequalities may widen.

Economic Growth & Environmental Degradation

• There are negative externalities of production that arise from producing a higher output of goods and services.

• Rapid economic growth results in higher emissions of greenhouse gases.

• Higher national income is likely to result in higher levels of household waste.

• Producing a higher level of output may also involve the depletion on non-renewable resources.

Economic Growth & Sustainable Development

• Economic growth may come at the expense of sustainable development – there may be a threat to sustainability.

• The extent to which this occurs may be diminished if the more educated and wealthier citizens demand policies and develop technologies that promote sustainability.

Summary Economic Growth

• Deflationary Gaps or output gaps may be the result of a fall in economic growth or negative economic growth in the short run.

• They may be solved using demand management policies (expansionary fiscal and monetary policies)

• Such policies may narrow the fluctuations in economic activity shown on the business cycle diagram.

• The trend growth line shown on a business cycle diagram is influenced by the supply side policies that generate long term economic growth

Evaluation of Economic Growth

• You should be able to evaluate the consequences of both demand and supply side policies, in terms of their likely success in achieving their goals, their appropriateness in different situations, the consequences for different stakeholders and the possible trade-offs (opportunity costs) that occur in the pursuit of different goals.

Calculating the Economic Growth Rate for a Country

• You may be asked to calculate the rate of economic growth from a set of data.

The formulae for the rate of growth is:

Growth Rate = Real GDP Year 2 – Real GDP in Year 1 Real GDP in Year 1 x 100

Historical Canada GDP Growth Example

YEAR REAL GDP GROWTH RATE2006 12830332007 1311260 1311260-1283033

1283033 x 100= 2.2%2008 1318054 1318054 - 1311260

1311260 x 100= 0.51%2009 1285604