Understanding Economic Growth Dynamics

Mar 6, 2025

Lecture Notes: Economic Growth

Definition of Economic Growth

  • Economic Growth: An increase in real GDP within an economy over a year.
  • Caused by:
    • Increase in Aggregate Demand (AD)
    • Increase in Long-Run Aggregate Supply (LRAS)

Types of Economic Growth

  1. Short-Run Growth (Actual Growth)

    • Occurs with an increase in Aggregate Demand (AD).
    • Utilizes spare capacity to increase output of goods and services.
    • Diagrams Used:
      • AD/AS Diagram: Demonstrates a shift of AD to the right, closing a negative output gap, moving towards full employment Y_F.
      • Production Possibility Frontier (PPF) Diagram: Illustrates movement from inside the PPF towards the PPF, showing utilization of spare capacity.

  2. Long-Run Growth (Potential Growth)

    • Occurs with an increase in Long-Run Aggregate Supply (LRAS).
    • Indicates an increase in the productive capacity of the economy.
    • Diagrams Used:
      • AD/AS Diagram: Shift of LRAS to the right, increasing potential growth rate from Y_F1 to Y_F2.
      • PPF Diagram: Outward shift of the curve, representing increased productive capacity.

Causes of Short-Run Growth

  • Factors affecting AD components (C + I + G + (X-M)):
    • Lower Interest Rates: Encourages borrowing for consumption and investment, weakens exchange rate.
    • Lower Taxes:
      • Income Tax: More disposable income, increases consumer spending.
      • Corporation Tax: More retained profits for investment.
    • Higher Consumer/Business Confidence: Increases C and I.
    • Higher Government Spending: Directly increases G.
    • Weaker Exchange Rate: Boosts net exports (X-M).

Causes of Long-Run Growth

  • Factors shifting LRAS:
    • Increase in Quantity of Factors of Production:
      • Larger workforce (e.g., immigration)
      • New resource discoveries
    • Increase in Quality of Factors of Production:
      • Enhanced labor productivity
      • Technological advancements
    • Increase in Productive Efficiency:
      • Reduction in long-run costs
      • Infrastructure improvements
      • Increased competition
  • Investment:
    • Spending on capital goods (e.g., machinery, technology)
    • Results in increased capital quantity/quality and reduced long-run production costs.

Conclusion

  • Understanding both actual and potential growth is crucial.
  • Ability to illustrate growth on diagrams and comprehend specific causes.

Note: The next session will cover the economic cycle.