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TOPIC 5
Economic growth
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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
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Definition
• Economic growth – a sustained
upward trend in the total output of
goods and services in a nation.
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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
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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
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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 -
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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 (%)
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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
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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.
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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
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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