Economic Growth

Chapter 7…

Target for GDP: 3 - 4%

Definition: An increase in capacity of an economy to produce goods and services over time.

• The increasing capacity of the economy to satisfy the material wants of the society.

1. Potential Growth: The rate of increase in the capacity of the economy to satisfy the needs and wants of people in an economy
2. Actual Growth: The rate of change in real gross domestic product over a given period of time.

This relates to Australia’s macroeconomic objective of sustainable economic growth.

PPF Model (Production Possibility Frontier)

Axis:

• X Axis: Consumer Goods
• Y Axis: Capital Goods

Actual Growth

If economy is operating inside the PPF, 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 by a movement of a point from within the PPF towards the PPF curve.

Potential Growth

The productivity potential of an economy may be increased by an increase in the quality and/or quality of resources and, when this occurs, this is known as potential growth.

• Potential Growth is illustrated by a movement of the PPF curve itself outwards

Measuring Economic Growth

The economic growth rate is the rate of change in GDP

GDP: The total market value of all final goods and services produced in a country during a certain time period

Calculation:

\[\frac{GDP_{yr2}\space - GDP_{yr1}}{GDP_{yr1}}*100\]

Types of GDP:

• Nominal GDP: The value of output expressed in the prices of the day
• Real GDP: Value of GDP after taking into account the value of inflation
  • Real GDP growth rate (%)
    • Nominal GDP growth rate - Inflation Rate Real GDP per Capita: Average real GDP per person in the population

Limitations of GDP:

• Residents can still be unhappy even when GDP increases
  • Doesn’t describe non-material welfare
• Doesn’t describe income distribution
• Non-market production is not accounted for
  • Black Market
  • Private
  • Volunteering
  • Cash Work
• It ignores externalities
• GDP can be not sustainable
• True Value of public goods and merit goods is largely unknown
• Understates changes in utility (Ability of goods and services to satisfy wants)
  • Doesn’t capture significant technological progress that increases utility without increasing price by much.
• Doesn’t account for rising productivity

Determinants of Economic Growth

Growth can come from both:

• Potential Growth
  • Those that increase the capacity of the economy to produce more goods and services with available resources (Supply Side)
• Actual Growth
  • How much expenditure is taking place to consume those goods and services (Demand Side)

Determinants of Potential Growth

Population Growth:

• Increase the total size of the economy : Greater demand for G + S and productive factors
• Increase in size of labour force: Migration and natural increase
• Migration more than natural: Migration promotes transfer of wealth, knowledge, skills and positive fiscal impact.

Labour Force Participation

• Proportion of people over 15 years old who are in paid work or actively looking for work
• Higher involvement at work: Increase capacity of production (overcome effect of aging workforce)
• Sustain government tax revenue

Rising Labour Productivity

• Amount of output produced per hour worked Capital Deepening
• Increasing the stock of capital relative to the stock of other productive resources
• Production becomes more capital intensive: Increasing about productivity
• Technology changes and improvements of function which hel to increase the amount of output. Capital Widening: Same thing but with more people as well

Multi-factor Productivity: All other factors that improve worker’s ability to produce goods and services (not capita)

• Changes in human capital, knowledge and skills that workers develop through education and experience, improved by education etc.

Determinants of Actual Growth

Anything that affects spending:

• Consumption
• Investment
• Government Expenditure
• Net Exports

Benefits and Costs of Economic Growth

Benefits

• Increased Consumption
• Higher Income
• Reduced Poverty
• Improved Government Finances
• Increase in material Standard of Living
  • Increased Quantity of goods and services
• Increased level of real income (After Inflation)
• Increased Life Expectancies
• Better Education
• Lower Unemployment
  • Growth is clearly likely to stimulate demand for labour
• Improved Efficiency
  • Better Quality of goods and services
• Fiscal Dividend
  • Rising income will lead to higher taxation revenue which can be used for public and merit goods such as infrastructure, health etc.
  • Public and merit goods generate considerable external benefits. More hospitals and schools mean a healthier and better educated population, which generates other economic benefits in terms of the effectiveness of the labour force.

Costs

• Inflation
• Income Inequality
  • May not raise the standard of living of everyone in the economy at the same rate
  • Booming Industry vs Failing Industries -> Widens the gap
• Pollution - Environmental Degradation
  • As production and consumption increase, negative externalities such as pollution and congestion are likely to arise. Increased depletion of non-renewable resources.
• Social Costs - Social Dislocation
  • Health Issues, Crime Issues, Disease
• Sustainable Economic Growth
• Structural Unemployment
  • From structural change -> When people want different types of goods and services or new inventions are invented.
• Inflationary Pressure
  • When resources are fully employed and the economy is working near its capacity