3.3.1 Economic growth Notes

1. Economic growth refers to an increase in a country's real gross domestic product (GDP) over time.
2. The real output is the value of an economy's national output after it has been adjusted for inflation. It reflects the true value of goods and services produced in a given year.
3. Economic growth is usually expressed as the country's annual percentage change in the value of the country's real national output.

There are two types of economic growth:

1. Short-term economic growth: changes in actual output within the existing capacity of the economy.
2. Long-term economic growth: expansion of the economy's productive capacity over time.

Short-term growth

1. Short-term economic growth occurs when an economy moves from operating below its capacity to producing more within its current resources.
2. This is represented as actual growth in the PPC model and by changes in aggregate demand (AD) in the AD/AS model.

Actual growth in the PPC model

1. The Production Possibility Curve (PPC) represents an economy's maximum potential output given its available resources.
2. Short-term growth happens when an economy moves closer to its PPC, meaning previously unused resources (unemployed labor or idle factories) are now being utilized.
3. This is often caused by increases in demand, investment, or improved efficiency in production.

Figure 1 above illustrates actual growth in the PPC model of an economy producing manufacturing goods and agricultural goods:

1. An increase in the use of available resources through (for example) efficiency gains, allows more of both goods to be produced.
2. This moves the economy's production closer to its PPC from Point A to Point B, demonstrating actual growth.

Role of AD in the AD/AS Model

Aggregate Demand (AD) consists of:

$$AD=C+I+G+(X−M)$$

where:

• $C$ = Consumer spending.
• $I$ = Investment by businesses.
• $G$ = Government expenditure.
• $X−M$ = Net exports (Exports - Imports).

In the AD/AS model, short-term economic growth occurs when aggregate demand (AD) increases, leading to higher output and employment. This is showcased in Figure 2:

1. When AD shifts ($AD_1$ → $AD_2$), firms respond by producing more goods and services.
2. This establishes a new equilibrium ($Y_1$,$Pl_1$ → $Y_2$,$Pl_2$), leading to an increase in real output ($Y_1$ → $Y_2$) and economic growth.
3. This economic growth happens without an increase in production possibilities (notice how LRAS stays constant).
4. However, the increase in real output comes at the expense of inflation ($Pl_1$ → $Pl_2$).

Long-term growth

1. Long-term economic growth occurs when an economy expands its productive capacity, meaning it can produce more goods and services over time.
2. This is represented by an outward shift of the PPC and an increase in Long-Run Aggregate Supply (LRAS) in the AD/AS model.

Shifts of the PPC (growth in production possibilities)

1. Long-term growth is shown by an outward shift of the Production Possibility Curve (PPC), meaning the economy can produce more of all goods.
2. This happens due to:
   1. Increases in quantity or quality of resources (higher labor force, better technology).
   2. Investment in infrastructure and education, improving productivity.
   3. Technological advancements, making production more efficient.

Figure 3 above illustrates growth in production possibilities in the PPC model of an economy producing manufacturing goods and agricultural goods:

1. An increase in the quality or quality of resource through (for example) increased immigration (larger labour force) increases the maximum quantity combination of both goods that can be produced at full-employment of resources.
2. This shifts the economy's PPC curve ($PPC_1$ → $PPC_2$), demonstrating growth in production possibilities.

Role of LRAS in the AD/AS Model

1. In the AD/AS model, long-term growth occurs when Long-Run Aggregate Supply (LRAS) increases.
2. LRAS represents the productive potential of the economy, meaning how much can be produced at full employment.
3. An increase in LRAS leads to:
   1. Long-term economic growth.
   2. Higher real GDP without causing inflation.

The impact and increase in LRAS has in real output is showcased in Figure 4:

1. When LRAS shifts ($LRAS_1$ → $LRAS_2$), buyers across the economy ($C+I+G+(X-M)$) are willing to buy more real output.
2. This establishes a new equilibrium ($Y_1$,$Pl_1$ → $Y_2$,$Pl_2$), leading to an increase in real output ($Y_1$ → $Y_2$) and economic growth.
3. This economic growth happens with an increase in production possibilities.
4. Furthermore, the increase in real output comes with a decrease in price levels ($Pl_1$ → $Pl_2$).

Measurement of economic growth

Economic growth is calculated as the percentage change in real GDP:

$$\text{Economic Growth Rate} = \frac{\text{New Real GDP} - \text{Old Real GDP}}{\text{Old Real GDP}} \times 100$$