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Economic Growth
Gross Domestic Product is the market value of all final goods and services
produced within a country in a given period of time.
Nominal GDP is the value of the final goods and services produced ina given year
valued at the prices that prevailed in that same year
Real GDP is the value of the final goods and services produced in a given year
when valued at constant prices.
Economic growth rate is the rate of change of real GDP expressed as a percentage
per year.
Growth rate = Real GDP year 2 – Real GDP year 1 /Real GDP year 1 x 100
For example, if real GDP in the current year is $8.4 trillion and real GDP in the
previous year was $8.0 trillion, then the growth rate of real GDP is
Growth rate = Real GDP year 2 – Real GDP year 1 /Real GDP year 1 x 100
Growth rate = $8.4 trillion - $8.0 trillion / $8.0 trillion x 100 = 5%
The growth rate of real GDP tells us how rapidly the total economy is expanding.
But it does note tell us anything about changes in the standard of living. The
standard of living depends on the real GDP per person which is Real GDP divided
by the population.
Example
Suppose for example, that in the current year, when real GDP is $8.4 trillion, the
population is 202 million. Then real GDP per capita is
$8.4 trillion/202 million = $
Suppose that in the previous year, when real GDP was $8 trillion, the population
was 200 million. The real GDP per capita in that year was
$8.0 trillion/200 million = $
Growth rate of real GDP per capita = $ - $/$ x 100 = %
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There is another way to calculate the growth rate of real GDP per capita.
What is it?
This formula makes it clear that real GDP per capita grows only if real GDP grows
faster than the population growth.
The Magic of Sustained Growth
Rule of 70 – the number of years it takes for the level of any variable to double is
approximately 70 divided by the annual percentage growth rate of the variable
Growth rates
Growth rate (% per year)
1
2
3
4
5
6
7
8
9
10
Years for level to double
70
35
23
18
14
12
10
9
8
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Question
Mexico’s real GDP was 1448 billion pesos in 1998 and 1501 billion pesos in 1999.
Mexico’s population growth in 1999 was 1.8%. Calculate:
a. Mexico’s economic growth rate in 1999
b. The growth rate of real GDP per capita in Mexico in 1999
c. The approximate number of years it takes for real GDP per capita in Mexico
to double if the 1999 economic growth rate and population growth rate are
maintained
d. The approximate number of years it takes for real GDP per capita in Mexico
to double if the 1999 economic growth rate is maintained but the
population growth slows to 1% a year
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Difference between actual and potential economic growth
The economy inside the PPC
Figure 3 Unemployment=Inefficient resource use
The economy may be producing at some point inside the curve (producing less of
both goods). There are two main reasons for this:
1 Unemployment of resources
2 Inefficient use of resources
So, in figure 3 the solid curve is the PPC with full employment, while the dotted
line is the PPC with unemployment.
Actual growth
If an economy is operating inside its PPC and produces more as a result of using
previously unemployed resources, or using resources more efficiently, this is
referred to as actual growth. This is illustrated in figure 4 below by a movement
from a point within the PPC to a point towards or on the PPC.
Figure 4 Actual growth
The movement from point Z towards the PPC represents an increase in actual
growth.
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Potential growth
The productive potential of an economy may be increased by an increase in the
quality and/or quantity of resources and, when this occurs, this is known as
potential growth.
This is illustrated in figure 5 below by an outward shift of the PPC.
Figure 5 Potential Growth
This denotes an increase in the productive capacity or potential of the economy
as more of both goods can now be produced.
Difference between growth and development
Economic development is a broader concept than economic growth. While
economic growth is measured by the increase in a country's real level of output
over time, economic development might additionally involve changes in the
composition of output, a more equal distribution of income, greater access to
health care etc.
This difference can be illustrated using a PPC. The two previous diagrams
(Figures 4 and 5) indicate an increase in economic growth through an increase in
potential and actual output. Figure 6 below indicates economic development.
Figure 6 Economic Development
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The switch from PPC1 to 2 shows more of society's resources being used for the
production of health care and less for the production of luxury goods. This is one
indicator of economic development, providing sufficient people have access to
the greater health care.
Figure 7 Economic growth and development (occurring together)
The PPC has shifted outwards denoting economic growth, but proportionately
more of the economy's resources are now devoted to the output of health care
rather than luxury goods as compared with the original position (PPC1).
The productive potential of the economy has increased (economic growth) and
there has been a qualitative improvement in the composition of the nation's
output (economic development).
Source:
http://www.triplealearning.com/files/developers/a_z_economics/page_14.htm[
accessed Sunday 13th of September 2015]
The sources of economic growth
Real GDP grows when the quantities of the factors of production grow or when
persistent advances in technology make them increasingly productive. All the
influences on real GDP growth can be divided into those that increase
 Aggregate hours
 Labour productivity
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Aggregate Hours
Over time aggregate hours increase. In developed economies, this growth in
aggregate hours comes from growth in the labour force rather than growth in
average hours per worker.
Population growth brings economic growth but it does not bring growth in real
GDP per capita unless labour hours become more productive.
Labour Productivity
The quantity of real GDP produced by one hour of labour is called labour
productivity. It is calculated by using the formula:
Labour productivity = real GDP/aggregate hours
For example, if real GDP is $8000 billion and if aggregate hours are 200 billion,
then we can calculate labour productivity as:
Labour productivity = $8000 billion/200 billion = $40 per hour
You can turn this formula around and see that:
Real GDP = Aggregate hours x labour productivity
When labour productivity grows, real GDP per capita grows. So the growth in
labour productivity is the basis of rising living standards. The growth of labour
productivity depends on three things:
 Savings and investment in physical capital – increase the amount of capital
per worker and increase labour productivity
 Expansion of human capital – human capital which is the accumulated
skills and knowledge of people comes from education & training and job
experience
 Discovery of new technologies – the development of writing, development
of mathematics which laid the foundation for the eventual extension of
knowledge in the sciences and more advanced technologies embodied in
physical capital have laid the conditions for great spurts in economic
growth in the last 200 years.
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Robert Solow’s One-third rule
This is an observation discovered by Robert Solow of MIT. One average, with no
change in human capital and technology, a 1% increase in capital per hour of
labour brings a one-third percent increase in labour productivity.
We can use the one –third rule to identify the contribution of capital growth to
labour productivity growth. Suppose, for example, that in a year, capital per hour
of labour grows by 3% and labour productivity grows by 2.5%. The one-third
rule tells us that capital growth has contributed one-third of 3% which is 1%.
Labour productivity growth that is not attributed to capital growth arises from
human capital growth and technological change. In the above example in which
labour productivity grows by 2.5% and capital growth contributed 1%, the
remaining 1.5% growth of labour productivity comes from human capital growth
and technological change.
Question
The table provides some data on the Canadian economy in 1998 and 1999
Item
Aggregate
hours
(billions)
Real GDP (billions of
1992 dollars)
Capital per hour of labour
(1992 dollars)
a)
b)
c)
d)
1998
25.0
1999
25.2
840
880
127
130
Calculate the growth rate of real GDP in 1999
Calculate labour productivity in 1998 and 1999
Calculate the growth rate of labour productivity in 1999
If the one-third rule applies in Canada, what were the sources of labour
productivity growth in 1999? Explain your answer
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