Economic growth is defined as a long-term expansion of the productive potential of the economy. Sustained economic growth should lead higher real living standards and rising employment. Short term growth is measured by the annual % change in real GDP. Economic growth is an increase in real national output or an expansion of the economy’s long-run productive potential. It is measured by the percentage change in real GDP or GNP. Inevitably there are fluctuations in the rate of growth from year to year and from quarter to quarter.
A distinction needs to be made between short run growth - resulting from making greater use of available resources to increase output and long-run growth - which comes from expanding the productive potential of the economy through improvements to the supply-side of the economy. Economic fluctuations—the business cycle Variations in growth are part of the business or trade cycle - the real volume of national output does not rise or fall at a uniform rate. Different stages of the economic cycle can be identified:
Recession: A fall in real output - associated with a fall in demand for goods and services and a contraction in employment, investment and profits.
Recovery: A rebound in national output (either from higher consumer demand, government spending, investment or an increase in net exports). The recovery phase can see strong output growth without causing inflation because there is plenty of spare capacity left in the economy.
Boom: Fast growth - where the actual rate of growth exceeds the long run trend rate of growth. The boom can have demand and/or supply-side causes but there is a risk of demand-pull and cost-push inflation emerging. This is because of excess aggregate demand for goods and services and shortages of factor resources.
Slowdown: This phase of the cycle follows on from a cyclical boom. The rate of growth of output slows down relieving some of the demand-pull inflationary pressure. A sharp slowdown may develop into a full-blown recession (known as a "hard-landing") or the slowdown may be mild (a "soft-landing") in which case real output and incomes continue to rise albeit at a slower rate.
Driving the trend growth rate
Many factors influence the rate of economic growth. Some factors, such as changes in consumer and business confidence, aggregate demand conditions in country’s trading partners, and monetary and fiscal policy, tend to have a mainly temporary effect on growth. Other factors, such as the rates of population and productivity growth, have more enduring effects, and help to determine the economy's average growth rate over long periods of time.
For our trend rate of growth to be higher, economy needs to do a number of things:
Raise capital investment spending as a share of national income.
Achieve higher productivity from both capital inputs and from our labour supply.
Expand the size of the labour supply, perhaps through an increase in the migration of high productivity workers.
Increase the level of research and development and increase the pace and application of innovation across the economy.
Growth and the Production Possibility Frontier
An increase in long run aggregate supply is illustrated by an outward shift in the PPF.
Advantages of Economic Growth
Sustained economic growth is a major objective of government policy – not least because of the benefits that flow from a growing economy. Higher Living Standards – for example measured by an increase in real national income per head of population. Employment effects: Growth stimulates higher employment.
Fiscal Dividend: Growth has a positive effect on government finances - boosting tax revenues and providing the government with extra money to finance spending projects The Investment Accelerator Effect: Rising demand and output encourages investment in new capital machinery – this helps to sustain the growth in the economy by increasing long...
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