Download economic growth

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 Growth
When 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 Growth
Education & 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 tradeoffs (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
2006
2007
2008
2009
REAL GDP GROWTH RATE
1283033
1311260 1311260-1283033
1283033
x 100= 2.2%
1318054 1318054 - 1311260
1311260
x 100= 0.51%
1285604