Economics (0455) | Economic growth

Welcome to Your Economic Growth Study Guide!

Hey there! This chapter is all about one of the most important goals for any government: making the country richer over time. Economists call this Economic Growth. Understanding how economies expand (and what risks come with that expansion) is crucial for understanding the whole subject of macroeconomics.

Don't worry if some of the terms seem new—we’ll break down exactly what growth is, how we measure it, and what governments can do to make it happen!

1. Defining and Measuring Economic Growth (4.6.1 & 4.6.2)

1.1 What is Economic Growth?

In simple terms, Economic Growth is the sustained increase in the output of goods and services produced by an economy over a specific period of time. This usually means the country is becoming wealthier.

• It must be sustained (it keeps happening, not just a one-off jump).
• It refers to the increase in the country’s ability to produce things, which we measure using GDP.

1.2 Measuring National Output: Gross Domestic Product (GDP)

The standard way to measure economic growth is by looking at changes in Gross Domestic Product (GDP).

• Definition: GDP is the total value of all final goods and services produced within an economy's borders in a specific period (usually a year).

Quick Tip: Why "Real" is Important!

When calculating growth, we must use Real GDP, not Nominal GDP. Why?

Imagine your country produced $100 billion worth of goods last year, and $110 billion this year. If prices (inflation) increased by 10% during that time, you haven't actually produced more stuff; you are just paying higher prices for the same stuff!

• Nominal GDP: Measured using current prices. This figure includes the effects of inflation.
• Real GDP: Measured using constant prices (prices from a base year). This figure removes the effects of inflation and accurately tells us if physical output has increased.
• Growth Rate: The rate of economic growth is the percentage change in Real GDP from one period to the next.

1.3 GDP Per Head (Capita)

While total GDP is useful, it doesn't tell us much about the average person’s welfare, especially if the population is also growing rapidly.

GDP per head (or GDP per capita) is a better indicator of the average standard of living. It shows the average income earned by each person.

The calculation is simple:

\[ \text{Real GDP per head} = \frac{\text{Real GDP}}{\text{Total Population}} \]

2. Recession and the Production Possibility Curve (PPC) (4.6.3)

If economic growth is the economy expanding, what happens when it shrinks?

2.1 Defining a Recession

A recession is usually defined as two or more consecutive quarters (i.e., six months or more) of negative economic growth (a fall in real GDP).

Did you know? During a recession, firms cut back on production, investment falls, and unemployment rises.

2.2 Recession and the PPC

We can use the Production Possibility Curve (PPC) diagram (which you studied earlier) to show a recession:

• The PPC shows the maximum potential output of an economy.
• During a recession, the economy is moving within its PPC boundary (for example, from point A to point B).
• This movement means the economy is operating inefficiently because resources (like labour and capital) are currently unemployed or underutilised.

3. The Causes of Economic Growth (4.6.4)

There are two main ways an economy can experience growth, and it’s important to know the difference!

3.1 Short-Run Growth: Utilising Idle Resources

This type of growth happens when the economy moves from inside the PPC (like during a recession) towards the PPC boundary.

• Cause: An increase in total demand (e.g., consumers start spending more or the government increases investment).
• Effect: This increase in demand leads to the utilisation of resources that were previously idle (unemployed workers return to work, empty factories start producing).

Analogy: If your car is capable of driving 100 km/h but you are only driving 60 km/h, speeding up to 90 km/h is short-run growth. You are simply using existing capacity better.

3.2 Long-Run Growth: Shifting the PPC

This is the growth that increases the potential output of the economy, represented by the PPC shifting outwards (to the right).

• Cause: An increase in the quantity or quality of the factors of production (Land, Labour, Capital, Enterprise).
• Key Drivers:
1. Investment: Spending on new capital goods (e.g., building new factories, purchasing better machinery).
2. Technology: Developing and implementing new, more efficient ways of producing goods and services (e.g., automation, AI).
3. Quantity/Quality of Labour: An increase in population size, or improvement in skills through education and training.
4. Quantity/Quality of Land/Natural Resources: Discovering new oil fields or improving soil fertility.

Analogy: Long-run growth is like inventing a new type of engine that allows your car to drive at 150 km/h. You have permanently increased your capacity.

4. The Consequences of Economic Growth (4.6.5)

Economic growth is generally considered positive, but it comes with benefits and costs, which can vary significantly depending on whether the country is developed or developing.

4.1 Benefits of Economic Growth

These benefits apply to most economies:

• Higher Living Standards: Increased Real GDP per head means people can afford more goods and services, improving their quality of life.
• Lower Unemployment: As output increases, firms need more workers, leading to job creation and lower unemployment.
• Increased Government Revenue: Higher employment and profits mean the government collects more tax revenue (income tax, corporation tax). This revenue can then be spent on better public services like healthcare and education.
• Increased Investment: Firms are more confident about the future, leading them to invest more in new technology and capital, which further fuels future growth.

4.2 Costs of Economic Growth

Growth is not without its drawbacks:

1. Inflation (Risk): If growth is driven purely by short-run demand increases without an equivalent rise in capacity, the economy may overheat, leading to demand-pull inflation.
2. Environmental Costs (Pollution/Resource Depletion): Higher output often means higher energy consumption and production waste, damaging the environment and depleting finite resources.
3. Income Inequality: The benefits of growth may not be shared equally. Owners of capital (the rich) often see their wealth increase faster than the incomes of low-skilled workers.
4. Stress and Social Disruption: Rapid industrialisation can lead to increased stress, longer working hours, and the breakdown of traditional communities as people migrate for work.

Context Matters: Different Economies

• Developing Economies: The benefits (reducing poverty, building infrastructure) often outweigh the costs, especially early on.
• Developed Economies: The costs (environmental damage, potential inflation) often become more prominent concerns, leading them to focus on sustainable or "green" growth.

5. Policies to Promote Economic Growth (4.6.6)

Governments use various macroeconomic policies (which you learned about in previous sections) specifically to target and promote growth.

5.1 Fiscal Policy for Growth

Fiscal policy involves the government changing taxation and spending levels.

• To promote short-run growth: Decrease direct taxes (leaving consumers with more disposable income to spend) or increase government spending on public projects (e.g., building roads). Both measures boost demand.
• To promote long-run growth (PPC shift): Increase government spending on key infrastructure (improving efficiency) and invest in education and training (improving the quality of labour).

5.2 Monetary Policy for Growth

Monetary policy involves changes in interest rates and the money supply, usually managed by the Central Bank.

• Action: Lowering the rate of interest.
• Mechanism: Lower interest rates make borrowing cheaper for consumers (boosting consumption) and for firms (boosting investment in new capital). This increases demand and helps achieve both short-run growth (utilisation) and long-run growth (investment).

5.3 Supply-Side Policies for Growth

These policies are the most direct way to achieve long-term growth because they directly improve the quality and efficiency of the factors of production, shifting the PPC outwards.

• Education and Training: Improves the quality of labour, making the workforce more productive.
• Labour Market Reforms: Making it easier for workers to move jobs or lowering the power of trade unions can increase the efficiency and mobility of labour.
• Lower Direct Taxes: Lower income taxes or corporation taxes can increase the incentive for people to work and for firms to invest.
• Deregulation and Privatisation: Removing unnecessary rules (deregulation) or moving state-owned companies to the private sector (privatisation) often increases competition and efficiency, leading to higher output.

Policy Effectiveness

The effectiveness of these policies depends heavily on the economic situation:

• If the economy is in a deep recession, fiscal and monetary policies aimed at boosting demand (short-run growth) are often the most effective first steps.
• If the economy is already near full capacity, only supply-side policies can ensure sustainable, non-inflationary long-run growth.