1 TOPIC 5 Economic growth 2 Lecture outline • Definition • Illustrating economic growth PPC Model Business Cycle AD/AS Model • Causes to economic growth Productivity growth – AS side AD side • Calculating economic growth Growth rate Nominal GDP versus Real GDP • Consequences of economic growth 3 Definition • Economic growth – a sustained upward trend in the total output of goods and services in a nation. 4 1. Economic Growth in the PPC Model • The common model used to illustrate economic growth are PPC model, Business Cycle, and the AD/AS model. PPC model – can be used to illustrate growth in number of ways • C • B • X • A 5 1. Economic Growth in the PPC Model Discuss the following: • Movement from point X to point A or B • Movement from points A or B to point C • Movement from point A to point B 6 1. Economic Growth in the PPC Model Movement from point X to A or B - • C Movement from point A or B to C (shift of PPC) - • B • X • A Reason to the shift of PPC curve - 7 2. Economic Growth in the Business Cycle LR growth SR growth SR growth • A business cycle illustrates both short run and long run economic growth. • The upward sloping sections of the business cycle represents periods of rapid short-run growth. • When level of demand grows more rapidly than the level of AS, output may increase beyond full employment level in the short run. • But as wages and input prices adjust to higher levels of demand, output will eventually fall and the period of growth is followed by contraction or recession. • A nation’s business cycle reflects periods of unsustainable short-run growth fuelled by fluctuations in AD, but also a long-run upward trend in output resulting from increases in the quantity and the quality of the nation’s resources over time.Despite short run fluctuation, most developed countries have experienced long run growth. 8 3. Economic Growth in the AD/AS Model • The most useful and detailed model for illustrating growth is the AD/AS model. • Economic growth occurs anytime a nation’s GDP increases. • An increase in GDP occurs any time AD increases when an economy is below its full-employment level of output. In the SR, if an economy producing at its full employment level experiences a rise in AD, it produces at a level of output beyond its full-employment level, although at a cost of higher inflation. 9 3. Economic Growth in the AD/AS Model • In the LR, however, an increase in AD alone does not result in economic growth since the wage rate increases and AS will shift left until output returns to its fullemployment level. • This means, in the LR, an economy cannot expect to increase its output beyond its full employment level by stimulating AD alone. • LR economic growth is achieved only when the nation’s full employment level of output increases. That is, when LRAS shifts outward. 10 3. Economic Growth in the AD/AS Model • Figure shows an economy experiencing LR economic growth – all 3 curves have shifted to the right. • Increases in C, I, G, NX may account for the shift in AD, but the increases in SRAS and LRAS are what allow this economy to achieve a greater level of output in the LR. Without increases in AS, this economy’s ability to grow is restrained to the full-employment level by its limited supply of land, labor and capital. 11 Economic Growth • An outward shift of a nation’s PPC is made possible only by an increase in the quantity or the quality of productive resources in the nation. • But how do more and better resources lead to economic growth? Answer is worker productivity. Production and Growth • Productivity refers to the amount of goods and services produced from each unit of labor input. • A nation’s standard of living is determined largely by the productivity of its workers. • In other words, productivity growth is the primary prerequisite for LR economic growth of a nation and improvement in per capital income and the average standard of living of a nation’s people. • A major source of increases in worker productivity is the increase in the quantity and the quality of the physical capital available to each worker in a nation. 13 Causes of Economic Growth Physical capital – the human-made resources employed in the production of goods and services such as robots, computers, buildings, tools. Higher national levels of private investment (I) increases the quantity and quality of physical capital which makes workers more productive, and leads to LR economic growth. Increases in the quality of capital and technology leads to vast improvements in worker productivity levels, and hence higher rates of growth. Improvement of technologies have transformed the structures of economies from agricultural based to industrial and service bases. This has resulted to higher income level and living quality. 14 Causes of Economic Growth Human capital – the value of labor created through education, training, knowledge and health. Increase in the physical capital increases labor productivity and promote economic growth. But a tool (technology) is only as useful as the worker operating it. Economist Julian Simon considered human ingenuity and creativity is the ‘ultimate resource’ that would allow human societies to overcome the physical scarcity of natural resources and thereby achieve long run growth (production beyond full-employment). Improved human capital with improved technologies higher economic growth. 15 Calculating Economic Growth GDP Growth rate (GR) • Positive growth rate indicates the total output increases from one year to another year. • Negative growth rate indicates recession, caused either by a decrease in AD or a decrease in AS. • Fall in growth rate may not be an evidence of recession. It could be due to lower growth rate than previous level. 𝑮𝑫𝑷𝟐 −𝑮𝑫𝑷𝟏 GR = x 100 𝑮𝑫𝑷𝟏 The table below shows the nominal GDP of country ABC from year 2011 to 2014. Compute the annual growth rate of country ABC YEAR NOMINAL GDP ($ BILLION) 2011 22.596 2012 31.758 2013 30.240 2014 35.425 GR (%) 16 Calculating Nominal GDP Goods and prices Quantity and price in 2010 Quantity and price in 2011 Quantity of calzones 4000 3500 Price of calzones $10 $15 Quantity of robots 500 550 Price of robots $200 $250 Nominal GDP Nominal GDP growth rate 17 Calculating Economic Growth Computing real GDP & real GDP growth • Nominal GDP is the total market value of all final goods and service. • A positive GR of nominal GDP tells us two things - either the quantity of the nation’s output increased or the price of the nation’s output increased, or both. • To compute the real GDP growth (the change in the total value of the goods produced calculated as if prices had stayed at the level they were in the base year), we must adjust the change in nominal GDP for the change in the price over the same period. 18 Calculating Economic Growth 𝐺𝐷𝑃𝑁 • Real GDP = 𝐶𝑃𝐼 ( 100 ) = 𝐺𝐷𝑃𝑁 (𝐶𝑃𝐼𝑥0.01) Converting Nominal GDP to Real GDP Price index (2010 base year): 𝑃𝐵2 x 100 𝑃𝐵1 Real GDP (2010 euros): 𝐺𝐷𝑃 𝑛 𝑝𝑟𝑖𝑐𝑒 𝑖𝑛𝑑𝑒𝑥 𝑖𝑛 ℎ𝑢𝑛𝑑𝑟𝑒𝑡ℎ Real GDP growth: =( 𝒓𝒆𝒂𝒍 𝑮𝑫𝑷𝟐𝟎𝟏𝟏 −𝑹𝒆𝒂𝒍 𝑮𝑫𝑷𝟐𝟎𝟏𝟎 ) 𝒓𝒆𝒂𝒍 𝑮𝑫𝑷𝟐𝟎𝟏𝟎 x 100 (210 / 210) 100 (265 / 210) x 100 = 126 140,000 / 1 = 140,000 190,000 / 1.26 = 150,793 19 5.0 Consequences of Economic Growth – group discussion • The economic consequence of growth in per capital GDP is an increase in the average level of income and consumption in a nation. • There are several non-economic consequences of growth that should be considered when evaluating growth as a goal of macroeconomic policymakers. • Externalities • Inflation • Resource depletion • Structural unemployment • Composition of output • Unequal income distribution • Effects on the balance of payment