Economic Growth
What is Economic Growth?
Economic growth is an increase in the capacity of an economy to produce goods and services, compared from one period of time to another.
Economic growth refers to an increase in aggregate productivity.
Causes of Economic Growth
Economic Growth is caused by two main factors:
an increase in aggregate in supply
an increase in aggregate supply
One major source of economic growth is investment.
Increased production of investment goods can only be achieved by a reduction in the production of consumption goods if the economy is at full employment. So there is a trade-off between consumption now and consumption in the future.
It is possible to achieve aggregate economic growth without an increased average marginal productivity through extra immigration or higher birth rates.
Distinction between the causes of actual and potential growth
Actual growth is caused by an increase in Aggregate Demand
Potential growth is shown by an increase in Aggregate Supply
Long term economic growth
Economic growth is only achieved if there is an increase in the long run aggregate supply (productive capacity)
LRAS or potential growth can increase for the following reasons:
Increased capital
Increase in working population
Increase in labour productivity (through better education, training and improved technology)
Discovering new or better economic resources
Technological improvements to improve the productivity of capital and labour
Economic growth can also be encouraged by more general factors, such as low inflation and interest rates and political and social stability.
Long-run aggregate supply can increase if there is an increase the quantity or quality of the inputs to the production process.
Land
Labour
Capital
Land in economics is defined as all natural resources, not just land itself, so land includes unprocessed raw materials.
Economic growth is likely to occur if
there is either an increase in the quantity of workers
Increases in the labour force can result from changes in the birth rate, increases in participation rates and increases in immigration.
there is an increase in the quality of labour
Workers need to be flexible
Labour is not homogeneous. Workers can be made more productive by education and training, so they can cope with the demands of the existing (and future) stock of capital.
There must be sustained investment in the economy to increase the stock of capital and to replace worn out capital (depreciation).
New investments can increase efficiency and cut costs
Constraint on Economic Growth
Economic growth may be reduced by inefficient economic and political structures.
Good governance is important to support economic growth.
Too much regulation and state interference may reduce entrepreneurial activity.
Too little investment in infrastructure by the government may reduce economic growth.
Problems exist where there are no properly functioning capital markets
Social and political unrest and instability will restrict economic growth.
Aggregate Demand
there is no point in an economy growing in terms of aggregate supply, if there is not a corresponding increase in aggregate demand.
A supply driven growth will only lead to a producer surplus
Increasing economic growth should encourage increased consumer spending and wealth.
In the short term, economic growth is caused by an increase in aggregate demand (AD).
If there is spare capacity in the economy then an increase in AD will cause a higher level of real GDP
AD can increase for the following reasons:
Lower interest rates
Increased wages
Increased government spending
Fall in value of sterling
Increased consumer confidence
Lower income tax
Rising house prices
Hysteresis
Hysteresis arises when a single disturbance affects the course of the economy.
Economics is the delayed effects of unemployment, possibly resulting from a demand deficient recession
As unemployment increases, more people adjust to a lower standard of living.
As they become accustomed to the lower standard of living, people may not be as determined to achieve the previously desired higher living standard. In addition, as more people become unemployed, it becomes more socially acceptable to be or remain unemployed.
After the labour market returns to normal, some unemployed people may be disinterested in returning to the work force. This results in loss of skills the longer people are out of work and potentially a 'brain drain' as skilled worker move to other countries in search of better employment opportunities.