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Define economic growth

Economic growth is a sustained expansion of production possibilities measured as the increase in real GDP over a given period


How to calculate growth rates

Economic growth rate is the annual percentage change of real GDP

To calculate the annual growth rate:
Growth of real GDP= real GDP in current year - real GDP in previous year divided by real GDP of previous year X 100.


Explain the difference between economic growth and business cycle expansion

Real GDP can increase for two distinct reasons:

1. The economy might be returning to full employment in an expansion phase of the business cycle.

2. Potential GDP might be increasing.

The return to full employment in an expansion phase of the business cycle isn't economic growth. The expansion of potential GDP is economic growth.

The growth rate of potential GDP measures the pace of expansion of production possibilities and smoothed out the business cycle fluctuations in the growth rate of real GDP.


How is standard of living calculated

The standard of living depends on real GDP per person. Real GDP per person is real GDP divided by the population. The contribution of real GDP growth to the change in the standard of living depends on the growth rate of real GDP per person.

Growth of real GDP per person = growth rate of real GDP - growth rate of population

Growth of population = current year population - previous year population divided by previous year population X 100

Real GDP per person grows only if real GDP grows faster than the population grows. If the growth rate of the population exceeds the growth of real GDP, real. GDP per person falls.


Explain sustained growth

Sustained growth of real GDP per person can transform a poor society into a wealthy one. The reason is that economic growth is like compound interest.


What is rule of 70

The number of years it takes for the level of any variable to doubles which is approximately 70 divided by the annual percentage growth rate of the variable.


Real GDP and potential GDP

Potential GDP is the value of real GDP when all the economy's factors of production are fully employed. We produce the goods and services that make up real GDP using factors of production: labour and human capital, physical capital, land and entrepreneurship. At any given time, the quantities of human capital, physical capital, land, entrepreneurship and the state of technology are fixed. But the quantity of labour is not fixed.

The quantity of labour employed depends on the choices of people and businesses. So real GDP produced depends on the quantity of labour employed. To describe the relationship between real GDP and the quantity of labour employed, we use a relationship called the production function.


What is the production function

Production function is a relationship that shows the maximum quantity of real GDP that can be produced as the quantity of labour employed changes and all other influences on production remain the same.

The production function is a boundary between the attainable and the unattainable. The production function displays diminishing returns; the tendency for each additional hour of labour employed to produce successively smaller additional amounts of real GDP.


Explain the demand for labour

The demand for labour is the relationship between the quantity of labour demanded and real wage rate when all other influences on firms hiring plans remain the same. The lower the real wage rate the greater is the quantity of labor demanded.


Explain the supply of labour

The supply of labour is the relationship between the quantity of labour supplied and the real wage rate when all other influences on work plans remain the same.


Explain the labour market equilibrium

A rise in the real wage rate eliminates a shortage of labour by decreasing the quantity demanded and increasing the quantity supplied. A fall in the real wage rate eliminates a surplus of labour by increasing the quantity demanded and decreasing the quantity supplied. If there is neither a shortage or a surplus the labour market is in equilibrium

When the labour market is in equilibrium the economy is at full employment. When the economy is at full employment, real GDP equals potential GDP.


Explain growth of the supply of labour

When the supply of labour grows, the supply of labour curve shifts rightward. The quantity of labour at a given real wage rate increases. The full employment quantity of labour is the labour force multiplied by average hours per worker. The labour force equals the participation rate multiplied by the working age population, divided by 100. The quantity of labour changes as a result of changes in average hours per worker, the labour force participation rate and the working age population. As the work week become shorter and more women entered the labour force, average hours were constant. Growth in the supply of labour comes from growth in the working age population, which grows as the same rate as the total population.


What determines the growth rates of the factors of production and the rates of increase in their productivity

Real GDP growth contributed to improving our standard of living.

But our standard of living improved only if we produce more goods and services with each hour of labour. So our main concern is to understand what makes labour more productive.


Explain the effects of population growth

Population growth brings an increase in the supply of labour but it does not change the demand for labour or the production function. With an increase in the supply of labour, the real wage rate falls and the equilibrium quantity of labour increases. The increased quantity of labour produces more output and potential GDP increases.


Explain labour productivity

Labour productivity is the quantity of real GDP produced by one hour of labour.

Labor productivity = real GDP divided by aggregate hours

If labour productivity increases, firms are willing to pay more for a given number of hours of labour, so the demand for labour also increases. With an increase in demand for labour and no change in the supply of labour, the real wage rate rises and the equilibrium quantity of labour increases. So an increase in labour productivity increases potential GDP for two reasons; labour is more productive and more labour is employed.


What are the preconditions for productivity growth

The fundamental precondition for labour productivity growth is the incentive system created by the economic freedom, property rights, firms, markets and money.

Economic freedom is present when people are able to make personal choices, their private property is protected by the rule of law, and they are free to buy and sell in markets.

Property rights are the social arrangements that govern the protection of private property.

Economic freedom and property rights: enable people to create firms- the organisations that enable labour and capital and ideas to cooperate in the wealth creation process, enable free markets to function, permit the creation of money and a system of monetary exchange which facilitates the smooth functioning of markets that make specialisation and trade possible.


What does the growth of labour productivity depend on

Physical capital growth: the accumulation of new capital increase capital per worker and increases labour productivity

Human capital growth: human capital acquired through education, on the job training and learning by doing is the most fundamental source of labour productivity growth.

Technological advances: the discovery and the application of new technologies and new goods has contributed immensely to increasing labour productivity.


Explain new growth theory

New growth theory is that our unlimited wants will lead us to ever greater productivity and perpetual economic growth. According to new growth theory, real GDP per person grows because of the choices people make in the pursuit of profit.

The new theory of economic growth emphasises three facts about market economies:

Human capital grows because of choices: people decide how long to remain in school, what to study and how hard to study etc for example

Discoveries result from choices: new discoveries because certain discoveries were chosen to be looking at and studied

Discoveries being profit and the competition destroyed profit: the forces of competition squeeze profits, so to increase profit people constantly seek either lower cost methods of production or new and better products for which people are willing to pay a higher price. Two other facts play a key role in the new growth theory: many people can use discoveries at the same time. Physical activities can be replicated.


What are some policies to achieve faster growth

To achieve faster economic growth we must increase: the growth rate of capital per hour of labour or the growth rate of human capital or the pace of technological advance. The main actions that governments can take to achieve these objectives are: create incentive mechanism, encourage saving, research and development and international trade and improve the quality of education.