In this lesson summary review and remind yourself of the key terms and concepts related to economic growth, including expansion of capital, technological change, and human capital.
An economy grows when it has the capacity to produce more. Production is based on how much capital, labor, natural resources, and technology it has to produce. Policies that encourage the accumulation of any of these leads to economic growth.
We’ve already seen the capacity to produce represented in two models: the production possibilities curve and the long-run aggregate supply curve. Economic growth is a shift out of either of these curves.
|economic growth||a sustained increase in real GDP per capita over time|
|output per capita||(also called real GDP per capita) output divided by population; for example, if real GDP is |
|productivity||(also called labor productivity) the amount of output produced per unit of labor|
|human capital||improvements in education, knowledge, and wealth that make each unit of labor more productive|
|supply-side policies||government policies that promote rightward shifts of aggregate supply, such as increasing labor force participation and incentives to save and invest|
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An increase in real GDP is not necessarily economic growth
Economic growth means that an economy has increased its ability to produce more. When an economy is producing beyond potential output, it might have experienced an increase in real GDP, but that is not economic growth. Similarly, an economy that is recovering from a recession might experience an increase in real GDP, but that is not economic growth.
Sources of economic growth
Economic growth is an increase in the capacity to produce. Therefore anything that increases that capacity is economic growth.
The ability to produce depends on:
- The stock of capital per worker: All else equal an economy with more physical capital can produce more than an economy with less physical capital. Because savings and investment add to the stock of capital, more investment in capital leads to more economic growth.
- The amount and quality of labor: As long as the capital per worker does not decrease, more labor leads to more production. For example, 4 people that each have a waffle maker make fewer waffles than 10 people that each have a waffle maker. Also, improvements in human capital, such as education and health, improve the productivity of that labor.
- The level of technology
- the know how to combine labor, capital, and natural resources to produce is an important aspect of production. Improvements in technology increase productivity.
Government policies can impact economic growth
Government policies play a big part in encouraging (or discouraging) economic growth. Some examples of economic policies that contribute to economic growth are:
- Investing in infrastructure: infrastructure, like highways or bridges, are physical capital that is available to everyone. By investing in infrastructure, governments add to the capital stock of a country. But infrastructure depreciates, just like any other capital. That means governments must replace depreciated infrastructure to maintain it.
- Policies that affect productivity and labor force participation
- Encouraging a higher labor force participation rate, such as tax incentives on labor for participation, can lead to more economic growth.
- Policies that encourage capital accumulation and technological change
- Policies that encourage savings, and therefore investment in capital, lead to higher economic growth. Similarly, policies that encourage technological change, such as tax credits for research and development, also lead to more economic growth.
Economic growth in the production possibilities curve (PPC) model
The production possibilities curve illustrates the maximum combination of output of two goods that an economy can produce, such as capital goods and consumption goods. If that curve shifts out, the capacity to produce has increased.
Economic growth in the AD-AS model
Recall that the long-run aggregate supply curve (LRAS) is vertical at the full employment rate of output. That means that if the full employment output increases (in other words, moves to the right along the horizontal axis), then the LRAS curve shifts to the right:
- Economic growth is the long-run trend of an increase in output over time, not just a temporary fluctuation in output or using previously underutilized resources.
Questions for review
- Show the impact that an increase in the supply of loanable funds would have on the PPC of an economy. Explain.
- Show the impact that a decrease in the capital stock would have on the LRAS of an economy. Explain.