ECONOMIC GROWTH

• Economic growth means an increase in real GDP – which means an

increase in the value of national output/national expenditure

• Economic growth is an increase in the production of economic goods

and services, compared from one period of time to another.

• Economic growth, the process by which a nation’s wealth increases

over time. Although the term is often used in discussions of short-term
economic performance, in the context of economic theory it generally
refers to an increase in wealth over an extended period.
• In simplest terms, economic growth refers to an increase in aggregate
production in an economy. Often, but not necessarily, aggregate gains
in production correlate with increased average marginal productivity.
That leads to an increase in incomes, inspiring consumers to open up
their wallets and buy more, which means a higher material 
quality of life or standard of living.
Measurement of economic growth
• Economic growth in a country is measured by the country’s Gross
Domestic Product (GDP) in one year.
o It measures only what has been produced within the country--this
doesn’t include products that are imported.
o It is much better for the economy of a country to produce its own
goods and services (this increases the country’s GDP).

• Measuring the GDP each year can:

• Compare one country’s economy to another
• Check a country’s economic progress over time
• Show if the economy is growing or not
GDP ( Gross Domestic Products)
• GDP is the total value of all the goods and services produced in that
country in one year.
• It measures how rich or poor a country is.
• It shows if the country’s economy is getting better or worse.
• Raising the GDP of a country can improve the country’s standard of
living.
Factors of Production
• There are 4 factors of production that influence economic growth
within a country:
1. Natural Resources available
2. Investment in Human Capital
3. Investment in Capital Goods
4. Entrepreneurship

• The presence or absence of these 4 factors determine the country’s

Gross Domestic Product (GDP) for the year.
Natural Resources
• All of the things found in or on the earth; “gifts of nature”.

• All resources are limited.

• Examples: land, water, sun, plants, time, air, minerals, oil, etc.
• Important to countries: without them, countries must import the
resources they need (costly)
• A country is better off if it can use its own resources to supply the
needs of its people.
• If a country has many natural resources, it can trade or sell them to
other countries.
Human Capital
• This is all of the skills, talents, education, and abilities that human
workers possess and the value that they bring to the marketplace.

• Examples: computer/reading/writing/math skills, talents in

music/sports/acting, ability to follow directions, ability to serve as
group leader & cooperate with group members

• A country’s Literacy Rate impacts Human Capital (the percent of the

population over 15 that can read/write).
• Nations that invest in the health, education, & training of their
people will have a more valuable workforce that produces more
goods & services.

• People that have training are more likely to contribute to

technological advances, which leads to finding better uses of natural
resources & producing more goods.
Capital Goods
• This is all of the goods that are produced in the country and then used
to make other goods & services.

• Examples: tools, equipment, factories, technology, computers,

lumber, machinery, etc.
• The more capital goods a country has, the more goods & services
they are able to produce.
• If a business is to be successful, it cannot let its equipment
break down or have its buildings fall apart.
• New technology can help a business produce more goods for a
cheaper price.

• Money is NOT a capital good, but rather a medium of exchange!

Entrepreneurship

• People who provide the money to start and operate a business are
called entrepreneurs.
• These people risk their own money and time because they believe
their business ideas will make a profit.

• They bring together natural, human, and capital resources to produce

foods or services to be provided by their businesses.
• Entrepreneurs have 2 characteristics that make them different from
the rest of the labor force:
• 1. innovative (have creative ideas)
• 2. risk taker (use limited resources in an innovative way in hopes
that people will buy the product)

• It can be several things:

• Starting your own business
• Inventing something new
• Changing the way something was previously done so that it works
better
• Entrepreneurship creates jobs and lessens unemployment.

• It encourages people to take risks, and in doing so, they’ve created

better healthcare, education, & welfare programs.

• The more entrepreneurs a country has, the higher the country’s GDP
will be.
Standard of Living
• The higher a country’s GDP, the better standard of living for the people
within the country.
• In order for a country to have an increasing GDP, it must invest in human
capital through education & training, and it must produce goods that
have value to be sold within the country or exported.
• To encourage economic growth and raise the living standards of its
citizens, there must be investment in human capital and capital goods.
• Economic growth is measured by increases in GDP over time.
• How large a nation’s GDP can be is determined by the availability and
quality of its natural, human, and capital resources.
• To increase economic growth and GDP over time requires investments in
both capital (factories, machines) and human capital (education, training,
skills of labor force).
Benefits of economic growth
• Higher average incomes
Economic growth enables consumers to consume more goods and
services and enjoy better standards of living. Economic growth during
the Twentieth Century was a major factor in reducing absolute levels of
poverty and enabling a rise in life expectancy.
• Lower unemployment.
With higher output and positive economic growth, firms tend to employ
more workers creating more employment.
Eg: UK unemployment rises during a recession – falls during periods of
economic growth.
• Lower government borrowing
Economic growth creates higher tax revenues, and there is less need to
spend money on benefits such as unemployment benefit. Therefore
economic growth helps to reduce government borrowing. Economic
growth also plays a role in reducing debt to GDP ratios.
A long period of economic growth in the post-war period helped reduce
the UK debt to GDP ratio.
• Improved public services.
Higher economic growth leads to higher tax revenues and this enables
the government can spend more on public services, such as health care
and education etc. This can enable higher living standards, such as
increased life expectancy, higher rates of literacy and a greater
understanding of civic and political issues.
• Money can be spent on protecting the environment.
With higher economic growth a society can devote more resources to
promoting recycling and the use of renewable resources.
• Investment
Economic growth encourages firms to invest, in order to meet future
demand. Higher investment increases the scope for future economic
growth – creating a virtuous cycle of economic growth/investment
• Increased research and development.
High economic growth leads to increased profitability for firms,
enabling more spending on research and development. Also, sustained
economic growth increases confidence and encourages firms to take
risks and innovate.
• Economic development
The biggest factor for promoting economic development is sustained
economic growth. Economic growth in south-east Asia over the past
few decades has played a major role in reducing absolute levels of
poverty – increasing life expectancy.
• More choice
In less developed economies, a large proportion of the population work
in agriculture/subsistence farming, economic growth enables a more
diverse economy with people able to work in service sector,
manufacturing and having a greater choice of lifestyles.
Costs of economic growth
• Inflation
If Aggregate Demand (AD) increases faster than Aggregate Supply
(AS), then economic growth will lead to higher inflation as firms put up
prices.
Economic growth tends to cause inflation when the growth rate is above
the long run trend rate of growth.
It is when demand increases too quickly that we get a positive output
gap and firms push up prices.
• Boom and bust economic cycles
If economic growth is unsustainable then high inflationary growth may
be followed by a recession. This occurred in the UK in the late 1980s
and early 1990s.
In the 1980s there was an economic boom with growth of over 4% a
year. However, this rate of economic growth caused inflation to rise to
over 9%. To reduce this inflation, the government increased interest
rates, and this rise in rates caused the economy to slow down and then
enter into a recession.
• Current account deficit
• Increased economic growth tends to cause an increase in spending on
imports, therefore, causing a deterioration on the current account.
• This shows that in the 1980s UK economic boom, there was an
increasing deficit in the balance of goods and services. In the late
1980s, there was high growth in consumer spending leading to a rise
in import spending. In the recession of 1991, there was an
improvement in the current account. The UK is susceptible to a current
account deficit during high growth because the UK has a high
marginal propensity to import.
• Environmental costs
Increased economic growth will lead to increased output and
consumption. This causes an increase in pollution. Increased pollution
from economic growth will cause health problems such as asthma and
therefore will reduce the quality of life. Economic growth also means
greater use of raw materials and can speed up depletion of non-
renewable resources. Economic growth can also lead to problems of
congestion as more people can afford to buy a car, but it is hard to
increase the supply of roads to meet demand.
• Inequality
Higher rates of economic growth have often resulted in increased
inequality because growth can benefit a small section of society more
than others. For example, those with assets and wealth will see a
proportionally bigger rise in the market value of rents and their wealth.
Those unskilled without wealth may benefit much less from growth.
However, it depends upon things such as tax rates and the nature of
economic growth. Economic growth can also be a force for reducing
absolute and relative poverty.
• Diseases/problems of affluence
With rising living standards it can cause unintended consequences. For
example, with rising incomes, there are more goods to steal. Also, high
growth can make people more materialistic – which encourages crime. 
Crime rates have risen since the 1930s. Also, higher incomes enable
people to afford more food – this is a factor behind rise in obesity and
health related problems.
Causes of economic growth
Factors which affect demand

• Lower interest rates

Lower interest rates reduce the cost of borrowing and so encourages
consumer spending and firms to invest. Lower interest rates also reduce
mortgage payments and so increase the disposable income of
consumers.
• Increased wages. Higher real wages increase disposable income and
encourage consumer spending.
• Increased government spending (G). e.g. government investment on
building new roads or increased spending on welfare benefits, which
increase disposable income.

• Devaluation. A fall in the value of the exchange rate (e.g. Pound

Sterling) makes exports cheaper and increases the quantity of exports
(X).  A depreciation also makes imports more expensive, reducing
quantity of imports and making domestic goods relatively more
attractive.
• Confidence. Increased consumer confidence encourages households
to spend by either running down savings or taking out more personal
credit. It enables higher spending (C)., which encourages spending
(C).
• Lower tax. Lower income tax will increase the disposable income of
consumers and increases consumer spending (C).
• Rising house prices. A rise in the price of houses creates a positive
wealth effect. Homeowners who see a rise in the value of their houses
will be more willing to spend (mortgaging house if necessary)

• Financial stability. If there is financial stability and banks are willing

to lend, then firms will be more willing to invest and investment will
increase aggregate demand.
Long-term economic growth

• This requires an increase in the long-run aggregate supply (productive

capacity) as well as AD. potential growth can increase for the
following reasons:
1.Increased capital. e.g. investment in new factories or investment in
infrastructure, such as roads and telephones.
2.Increase in working population, e.g. through immigration, higher
birth rate.
3.Increase in labour productivity, through better education and
training or improved technology.
4.Discovering new raw materials. For example, finding oil reserves
will increase national output

5.Technological improvements to improve the productivity of capital

and labour e.g. Microcomputers and the internet have both contributed
to increased economic growth. In the future, economic growth may
come from new technology such as Artificial intelligence (AI) which
enables robots to take the place of human workers.
Other factors affecting economic growth

• Economic and political stability. Stability is important for reassuring

firms it is a good idea to invest in increasing capacity. If we see a rise
in uncertainty, confidence tends to fall and this can cause firms to
delay investment.

• Low inflation. Low inflation is a good climate for encouraging

business investment. High inflation increases volatility.
Policies for Economic Growth
Demand side policies

• Demand side policies aim to increase aggregate demand (AD). This

needs to be done during a recession or a period of below-trend growth.
If there is spare capacity (negative output gap) then demand-side
policies can play a role in increasing the rate of economic growth.
However, if the economy is already close to full capacity (trend rate of
growth) a further increase in AD will mainly cause inflation.
Monetary Policy

• Monetary policy is the most common tool for influencing economic

activity. To boost AD, the Central Bank (or government) can cut
interest rates. Lower interest rates reduce the cost of borrowing,
encouraging investment and consumer spending. Lower interest rates
also reduce the incentive to save, making spending more attractive
instead. Lower interest rates will also reduce mortgage interest
payments, increasing disposable income for consumers.
Fiscal Policy

• The government can boost demand by cutting tax and increasing

government spending. Lower income tax will increase disposable
income and encourage consumer spending. Higher government
spending will create jobs and provide an economic stimulus.
Devaluation

• For countries stuck in a fixed exchange rate. Devaluation can help

restore competitiveness and boost domestic demand. A fall in the
exchange rate makes exports cheaper and imports more expensive.
• For example, Argentina and Iceland both had rapid devaluations,
which in the medium term helped their economic recovery. The UK
also benefited from leaving the exchange rate mechanism in 1992.
Quantitative Easing

• Quantitative easing involves increasing the money supply and buying

bonds to keep bond rates low. The hope is that the increase in the
money supply and lower interest rates will boost investment and
economic activity. The fear is that increasing the money supply could
cause inflation.
Supply-side policies

• The alternative strategy for improving economic growth is to use

supply-side policies. These attempt to increase productivity and
efficiency of the economy.
• Lower Income Taxes. It is argued lower income tax can boost the
incentive to work and increase labour supply.
• It is possible, if income taxes were excessive, then cutting them may
encourage people to work more. However, this argument is often
exaggerated.
• Flexible labour markets. Highly regulated labour markets, with
excessive regulation, may discourage firms from employing workers
and setting up in the first place.
• It is argued that countries such as France have too much labour market
restrictions, such as the cost of firing workers, maximum working
week and minimum wages.
• More flexible labour markets can thus provide a long-term boost to
investment. However, there is a trade-off. More flexible labour
markets could increase job insecurity and lead to harmful effects on
labour productivity.
• Better Union relationships. In the 1970s, the UK economy suffered
because of poor industrial relations. There were frequent strikes which
stopped production. With an adversarial attitude, it was difficult to
promote more labour efficient production processes. Reducing the
power of trades unions can help to improve labour productivity.
• Privatisation and deregulation.  Privatising industries can increase
efficiency as private firms have a greater profit incentive to cut costs
and boost productivity.
Types of economic growth
• Boom and bust economic cycles. If growth is very fast and
inflationary, then the growth will prove to be unsustainable and there
will be the costs of the recession and an economic downturn.
• Export-led growth. Economies such as Japan and China have
experienced export-led growth. This enables economic growth and a
current account surplus. China has increased its ownership of foreign
assets.
• Consumer-led growth. Since 1979, UK economic growth has been
more dependent on consumer spending. The UK has run a persistent
current account deficit with fears the economic growth is unbalanced.
• Commodity exports. Some countries very rich in resources have
economic growth based on production and export of raw materials.
For example, Saudi Arabia (oil), Venezuela (oil), Cuba (sugar) Congo
(oil and natural resources).
• Whilst export of raw materials can increase wealth, it can also cause
problems. The resource curse states countries which have growth
based on raw materials may struggle in long-term, as raw material
industries crowd out other manufacturing industries and make the
economic growth more volatile – depending on fluctuating prices.
Recessions
• A recession is a period of negative economic growth, where output
falls for two consecutive quarters. 
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