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Economics
Understanding Economic Growth
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Economics: Economic Growth
Economic growth
•
aggregate demand and its components: Y = C+I+G+X–M
•
injections and withdrawals (I+G+X; S+T+M)
•
the simple multiplier: k = 1/(1–MPC)
•
measurement of growth through changes in real Gross Domestic Product
•
sources and effects of economic growth in Australia
•
increases in aggregate supply – improvements in efficiency and technology
•
trends in business cycle
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Economics: Economic Growth
Economic growth
Economic growth can be defined as a change in a country’s productive capacity, measured
by changed in its real gross domestic product over time.
Real gross domestic product (GDP) refers to the market value of domestic output of
goods and services adjusted for inflation over a period of time. The consumer price index
(CPI) is used to convert nominal GDP to real GDP.
Real GDP is determined by a combination of aggregate demand and aggregate supply.
What is the formula for economic growth in terms of real GDP?
What is the formula that converts nominal GDP to real GDP?
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Economics: Economic Growth
Problems
Year
Real GDP ($ million)
1
360
2
480
3
460
4
550
Given the above data, calculate:
•
Economic growth in Year 2
•
Economic growth in Year 3
•
Economic growth in Year 4
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Economics: Economic Growth
Year
Nominal GDP ($M)
CPI
1
105
100
2
120
150
3
130
155
4
120
120
Real GDP ($M)
Given the above data, calculate:
•
Economic growth in Year 2
•
Economic growth in Year 3
•
Economic growth in Year 4
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Economics: Economic Growth
Aggregate demand and aggregate supply
Aggregate demand refers to the total amount of expenditure on domestic output. It is
given by the following formula, developed by John Maynard Keynes:
AD = C + I + G + X – M
Aggregate supply refers to the productive capacity of the economy – how much the
economy is able to produce.
Describe each component of aggregate demand.
C
I
G
X
M
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Economics: Economic Growth
We can create an aggregate demand and aggregate supply model by making an analogy to
the normal demand and supply model. Since aggregate demand is the demand for all goods
and services and aggregate supply is the supply of all goods and services:
•
The -axis will be the price of “all goods”, which we can call price levels (which you
will later learn is measured by the consumer price index).
•
The -axis will be the quantity of “all goods”, which we know as real GDP.
Sometimes, national income is used instead.
The price level and real GDP is determined by the intersection between the two curves,
where AD = AS.
Draw an aggregate demand and aggregate supply model.
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Economics: Economic Growth
Problems
Explain the effect of increased government spending on economic growth and inflation, using
the AD-AS model.
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Economics: Economic Growth
Explain the effect of increased training and education on the economy’s long run economic
growth and inflation.
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Economics: Economic Growth
Equilibrium level of national income
The consumption function tells us the level of consumption as a function of the level of
income.
C = C0 + cY
Similarly, since Y = C + S, the savings function is given by S = –C0 + sY.
Investment is assumed to be uninfluenced by income, and hence autonomous.
I = I0
Describe each component of the consumption function.
C0
c
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Economics: Economic Growth
You will be asked questions about the three sector model of the equilibrium level of national
income (consisting of households, firms and the finance sector). For these question, you
must remember that Y = C + S, and the formulas for the marginal propensity to consume
(MPC) and marginal propensity to save (MPS).
MPC =
ΔC
ΔY
MPS =
ΔS
ΔY
Example
The table shows hypothetical values for a three sector economy. Fill in the blank cells.
Y
C
0
50
50
75
100
100
150
125
200
150
S
I
MPC
MPS
100
What is autonomous consumption in this economy?
Write down the consumption function for this economy.
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Economics: Economic Growth
In this three sector economy, since there is no government or overseas sector, aggregate
demand is given by AD = C + I. The equilibrium level of national income occurs when AD =
AS, or when C + I = Y. You can also solve for equilibrium level of national income by
equating leakages and injections (S = I).
Write down the equation that represents total expenditure (E).
In a diagram with expenditure (E) in the -axis and income (Y) in the -axis, the above equation
and the line Y = E.
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Solve algebraically for the equilibrium national level of income by solving the equation
C+I=Y
Another method to find equilibrium level of income is to find when leakages equals injections.
Solve for equilibrium national level of income in this way.
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The simple multiplier
The simple multiplier refers to the extent to which a change in expenditure (consumption,
investment, government expenditure and net exports) is multiplied to give a larger change in
the equilibrium level of national income.
The formula for the simple multiplier k is:
k=
1
1
=
MPS
1 – MPC
Recall what MPC and MPS are.
Why does the multiplier effect occur?
For interested students
The formula for the multiplier is essentially the formula for an infinite geometric series. This
is because money is being spent “infinitely” around the economy, reducing at a ratio equal
to the MPS.
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Examples
Given the marginal propensity to save in an economy is 0.2, what is the multiplier?
The government injects $20 million into an economy with a marginal propensity to consume of
0.65. How much does this injection increase income in the economy by?
Given the marginal propensity to consume in an economy is 0.6, an increase in spending by
the government led to an increase in national income by $100 million. How much did the
government spend?
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Economics: Economic Growth
Problems
An increase in government spending of $10 million increases national income by $80 million.
What is the economy’s MPC?
What is the multiplier, given the data for an economy below?
Year
C
S
I
1
200
50
200
2
400
100
200
3
600
150
200
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Economics: Economic Growth
Sources of economic growth in Australia
Recall that real GDP is derived from aggregate demand and aggregate supply. Hence, the
sources of economic growth are the factors that can cause increase in aggregate demand or
aggregate demand.
List factors that have or can increase Australia’s economic growth that are based on aggregate
demand.
List factors that have or can increase Australia’s economic growth that are based on aggregate
supply.
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Keep updated
What is Australia’s current economic growth rate?
Describe trends in Australia’s economic growth in relation to the global economy in recent
years.
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Effects of economic growth in Australia
List the effects of economic growth in Australia.
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