Economic
Growth
Economic growth is the expansion of the productive capacity
of an economy (an outward shift of the PPF curve). This enables a society to
produce more goods and services. This can also be seen by an outward shift of
the aggregate supply curve which entails an increase in the full employment
output.
GDP doesn’t measure economic growth; it just measures output
but not an expansion in the potential output capacity of an economy. If an
economy is producing inefficiently (behind the PPF curve) in one year and the
next year it is producing efficiently (on the PPF curve) then this could be
perceived as growth but it isn’t actually economic growth as there hasn’t been
an outward shift of the PPF curve (and the potential output remains constant).
Production is made possible through the use of factors of
production – capital, labour, land and entrepreneurship. Capacity output is
reached when all factors of production are fully and efficiently utilised.
Therefore an increase in capacity output can be made possible from an increase
in the quantity of the factors of production, or from an improvement in their
efficiency or productivity (quality).
Productivity is a measure of the efficiency of a facture of
production. Labour productivity measures output per work. Capital productivity
measures output per unit of capital. Total factor productivity refers to the
average productivity of all factors measured as the total output divided by the
total amount of inputs used.
Capital is a critical factor in the production process and
thus an increase in capital is a source of economic growth. In order for this
to occur investment needs to have taken place.
Investment can be found in the national accounts under Gross
Fixed Capital Formation. This covers net additions to the capital stock but
also depreciation. This is the fall in value of physical capital equipment over
time due to wear and tear. Therefore the Gross Fixed Capital Formation includes
the purchase of new capital in order to offset depreciation and isn’t an addition
to the capital stock.
If an economy decide to pursue accumulating capital stock
through investment to increase its potential output then this is usually at the
expense of not producing as much consumer goods.
Labour is also a large contributor to the production process.
Apart from increase migration (a long-run policy) it is hard to increase the
size of a labour force. Therefore the quality of labour is a better policy to
pursue. This can be improved through education and training.
Constraints
on Growth
Absence of
capital markets – If firms don’t have access to cheap and easily
available funds then they will find it hard to invest and expand their
operations and hence there will be limited potential and actual growth.
Government
Instability – If governments are incompetent or weak then the economy
may not attract investment. If the government has high corruption or a fiscal
deficit then it may not spend much money which will prohibit growth.
Labour
Market Problems – A shortage of skilled labour is a major constraint
on growth.
Benefits of
Growth
There are benefits for employees, firms and governments from
growth. Employees are likely to see a rise in income and wealth as well as a
rise in the standard of living. Firms will see larger profits as consumer
spending usually rises during economic growth. Finally, governments are likely
to see a greater tax revenue which will allow them to spend more, eliminate a
deficit, or save for the future.
Costs of
Growth
Income
Inequality – Some members of society won’t benefit equally from growth
and so wages may become unequal. This provides issues for an economy.
Environmental
Problems – Depletion of natural resources and pollution is likely to
increase with economic growth.
Inflation – Rapid
growth can cause short term spikes in prices, which might increase the prices
of foods and basic goods, making it harder for poorer citizens in an economy to
buy the necessities to survive.
Page last updated on 20/10/13
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