This article includes introduction to economic growth.
It explains different ways of measuring economic growth and explains the differences between Gross Domestic Product (GDP) and Gross National Product (GNP).
It also describes the measures used to indicate economic growth and analyses the different stages of the economic cycle.
You will also find here causes (determinants) of economic growth as well as the analysis of benefits and costs of economic growth.
What is economic growth?
Potential economic growth is an increase in an economy’s ability of a country to produce goods and services which brings about a rise in standards of living. Actual economic growth is a rise in real Gross Domestic Product (GDP).
A Production Possibility Frontier (PPF) can be used to show potential output in an economy. It is represented by the solid curved line in the diagram below.
One way of achieving economic growth is to grow the potential output level. It is illustrated by the expanded Production Possibility Frontier (PPF) in the form of the dotted line.
Different ways of measuring economic growth
National income is used to show economic growth and there are many ways to calculate this figure. The two most common ways are:
- Gross Domestic Product (GDP)
- Gross National Product (GNP)
The difference between Gross Domestic Product (GDP) and Gross National Product (GNP) is that Gross National Product (GNP) includes income earned abroad on investments and assets minus income earned by foreigners on their investments and assets in the domestic economy.
Gross Domestic Product (GDP) is measured within a country’s defined geographical boundaries. While Gross National Product (GNP) is measured including all citizens of a country no matter where they live – both domestically and abroad.
Gross Domestic Product (GDP) per capita
As the economy of a nation grows, the citizens of that country should become wealthier. In order to determine whether or not people are becoming richer within an economy, the ‘GDP per capita’ can be used.
Gross Domestic Product (GDP) per capita can be determined by dividing the Gross Domestic Product (GDP) by the population size of the country. This will determine the average earnings of citizens.
The United States Gross Domestic Product (GDP) per capita was last recorded at USD$61,280.39 in 2021. The China Gross Domestic Product (GDP) per capita was last recorded at USD$11,188.30 in 2021.
Index numbers – Measures used to indicate economic growth
Information regarding economic growth is only useful, if comparisons are made either between different years or different countries. However, with such large numbers in use it is very difficult to read statistical information.
To combat this problem, economists use ‘index numbers’ to simplify their results and information.
| GDP per capita | GDP per capita (Index 2020 = 100) | |
| 2020 | USD$28,000 | 100 |
| 2021 | USD$33,600 | 120 |
| 2022 | USD$39,200 | 140 |
The chart above shows an example of index numbers. To make a comparison, a ‘base year’ must be chosen. In the example, the base year is 2020 and is changed to 100 to facilitate easy comparisons. The index number for 2021 is 120. This would tell a reader of the information that the economy had achieved growth of 20%, without the need for more complicated calculations.
When comparisons are made between the economic growth rates of different years, it is common to hear the following vocabulary:
- Real values. These are values which have been adjusted for inflation. They use the price level of the time period currently being studied, also known as constant prices.
- Nominal values. These are values which have not been adjusted for inflation, also known as current prices.
These different types of figures are useful because ‘nominal values’ show us figures as they are, but ‘real values’ allow us to see a clearer picture of increases in output.
In 1948, the value of the UK’s economy was £11.9 billion and £1,160.4 billion in 2004 in nominal value. As this number is not adjusted for inflation, so it shows a greatly increased figure. However, has output really increased this much? It is hard to tell because of the current prices used in both years.
In 1948, the value of the UK’s economy was £11.9 billion and £48 billion in 2004 in real value. As this number is adjusted for inflation, it can be easily seen that the UK economy has increased in size, since the value of goods and money in both years are the same (the constant price of 1948).
Different stages of the economic cycle
The Business Cycle is a model which shows the normal growth pattern of an economy. It is sometimes referred to as the ‘trade cycle’ or the ‘economic cycle’.
Upturns (increases) and downturns (decreases) in demand and output within an economy have a regular pattern. Actual growth is the level of output at a particular period of time. The actual output level fluctuates depending upon various economic conditions. Economies experience periods of growth and boom, but also troublesome times when the economy will slowdown or even enter a recession.
Trend output is the average growth represented in the business cycle.
The diagram above has different phases indicated and labelled 1 to 4 with each stage explained below:
- Upturn. The economy was experiencing problems, but this period sees the economy begin to recover. Recovery sees the actual output level rise and move closer to the trend line.
- Expansion. During the expansion phase, the economy is experiencing fast economic growth and resources are used more fully.
- Peak. During this phase growth is continuing, but is beginning to slow down and may eventually stop.
- Downturn or recession. Downturn occurs when there is no growth with the possibility of a reduction in actual output. A recession means that actual output has fallen over two quarterly periods or more. One quarter is equal to three months.
Full-capacity output, or the total output possible, would happen, if all resources in a country were efficiently used for production. This is not really likely.
Output gap is the difference between the actual output and the trend rate. If the actual output is above the trend line, it is known as a positive output gap. And, if it is below the trend line, it is called a negative output gap.
Causes of economic growth
Actual economic growth occurs when there is an increase in national output.
Potential growth is the result of an increase in the quality or quantity of resources used in the production process by the economy. The inputs used in the production process are the factors of production – land, labor, capital and enterprise (entrepreneurship).
It is also possible for actual growth to occur, if inputs are allocated and used more efficiently.
1. Land
Discovering and exploiting new natural resources can lead to economic growth. Modern industry requires a large amount of non-renewable resources. The discovery of new sources of these is a way to ensure continual growth in an economy. For example, the Middle East would not be as affluent, if vast quantities of oil had not been discovered. It must also be remembered that mankind now has access to renewable energy sources and capabilities in harnessing that power is growing.
2. Labor
Not all investment needs to be in technology. Economic growth can occur if the workforce is trained or educated to a greater degree. A well-educated workforce should be able to be more productive, and flexible enough to suit the needs of the changing business environment. An increase in the quantity of workers can also cause economic growth since more labour can contribute to output. Increased numbers can come from young people entering the workforce, larger numbers of women working or returning to work and also immigrants from abroad or from rural areas.
3. Capital
Investment can bring about new technology which can result in greater levels of production as new machinery speeds up manufacturing, improves production processes or the processing of information. Investment is not a guaranteed way to improve an economy though, as investments could be made in declining industries. Particularly, if the government wishes to save a state company or home-grown businesses which may not be beneficial in the long-term.
4. Enterprise (entrepreneurship)
Entrepreneurship the unique ability of certain people to organize all of the other factors of production in order to start a business organization. An increase in the quantity and quality of business owners and managers can cause economic growth since more entrepreneurial activities will happen in the economy. That is why these days many countries are actively fighting for talented professionals.
5. Other causes of economic growth:
- Social causes. Personal demand for fast Internet connections has led to huge investment into broadband Internet. This has increased communication methods around the world as well as creation of new industries.
- Political reasons. The European Union is strict on carbon dioxide emissions. Because of that, more efficient cars better suited to the environment have allowed resources such as oil and money to be freed up for use elsewhere.
Evaluation of economic growth
Benefits of economic growth include:
- Higher levels of employment. Greater output requires higher levels of labor.
Additional effects of this are lower social benefits spending from governments and fewer social problems.
- Increase in the standard of living. This not only brings about a more comfortable existence, but extends life expectancy and reduces the number of people who are living in poverty.
- TAX revenues. Although not great for the businesses and citizens who are taxed, higher TAX revenues allow government to increase spending, which should encourage further growth and help to provide merit goods and public goods.
- Investment. A growing economy will attract even greater investment from investors within the economy aiding further growth.
- Competitiveness. A growing economy finds itself more able to compete in the world economy. Being a leader tends to be more beneficial than being a follower. Increased competitiveness can lead to stronger political relationships and influence on the world stage.
- Trade. Higher levels of output mean that a surplus is more likely to be made which can be traded with other economies.
Costs of economic growth include:
- Technological unemployment. Economic expansion and investment lead to the development of new technologies and production techniques. However, improved technology often reduces the amount of labor required, especially in manufacturing industries.
- Inflation. If an economy grows too quickly, high levels of inflation can become a problem, if demand grows ahead of an economy’s ability to provide enough products and services.
- Higher interest rates. Increasing interest rates are a problem for a growing economy because consumers will save more reducing expenditure. Investment also suffers as the cost of borrowing money increases.
- Trade deficit. Households in a growing economy are likely to spend more money on luxury items, including imports. A trade deficit occurs when the value of imports exceeds the value of its exports. This deficit must eventually be repaid.
- Wealth gap widening. The wealth of a country may increase, but it does not necessarily mean that wealth is fairly distributed. If the gap between the rich and poor increases, more and more people will slip into poverty. The wealth gap may also be regional within an economy which can lead to social unrest.
- Negative externalities. Economic development can cause various negative externalities to occur. Pollution is a major problem caused by increased output in an economy, especially economies reliant upon secondary industries. An increase in the standard of living also causes larger amounts of waste to be produced as households consume more. Car ownership may increase which again adds to pollution released into the atmosphere. Additionally, people have more leisure time. This can result in less healthy lifestyles, which can cause problems such as obesity, heart disease and numerous other problems associated with over-eating, drinking and smoking.
Summary
There are many ways to determine the growth of an economy with Gross Domestic Product (GDP) and Gross National Product (GNP) being the most common.
The business cycle looks at how economies have upturns and downturns. Knowledge of this pattern can help all economic agents to make judgements about financial decisions. Whether they are businesses, governments or a private citizen.
Economic growth occurs for various reasons, which ultimately concern an increase in the quality and quantity of inputs to the economy. There are various benefits – employment and standards of living increase, as does investment and TAX for future investment. The country also experiences an increase in competitiveness and trade.
However, economic growth brought about by improving technology could reduce employment. Inflation and interest rates could increase beyond acceptable levels. Finally, the economy could witness a trade deficit and an increase in negative externalities.
