Economic Growth: An increase in the full employment output over time, not just an increase in real GDP.
Expansion: Increase in real GDP over time, without necessarily increasing full employment output.
Contraction: Decrease in real GDP.
Full Employment Output: The level of output an economy can produce when operating at full employment, without cyclical unemployment.
Understanding Economic Growth
Economic growth is independent of the economic cycle (expansions and contractions).
Economic growth is measured by an increase in the full employment output, not just real GDP.
Diagram Explanation
Real GDP vs. Time: Real GDP fluctuates around the full employment output.
Positive Output Gap: When the economy’s output is above full employment output.
No Economic Growth Example: If full employment output (Yf) remains constant from time T1 to T2, there is no economic growth despite an increase in real GDP.
Economic Growth Example: Full employment output increases over time, even during a contraction.
Production Possibilities Curve (PPC)
PPC: A curve showing the maximum possible output combinations of two goods/services an economy can achieve when resources are fully and efficiently utilized.
Negative Output Gap: When actual production is inside the PPC.
Expansion vs. Economic Growth: Returning to the PPC from a negative output gap is an expansion. Pushing out the PPC indicates economic growth.
Aggregate Demand and Aggregate Supply Model
Long-Run Aggregate Supply Curve (LRAS): Represents full employment output in the long run.
Positive/Negative Output Gaps: Short-term deviations from full employment output due to demand or supply shocks.
Shifts in LRAS: Economic growth is indicated by a rightward shift in the LRAS, suggesting an increase in full employment output.
Factors Contributing to Economic Growth
Capital: Increase in physical capital like factories, land, and resources.
Human Capital: Better educated and more skilled workforce contributes to productivity.
Technology: Advancements in technology that improve the efficiency of production processes.
Institutions: Efficient bureaucracies and institutions that facilitate economic activities and reduce friction.
Summary
Economic growth is about increasing the economy’s capacity to produce, not just short-term fluctuations in real GDP.
Key indicators of economic growth include the outward shift of the PPC and the rightward shift of the LRAS in the aggregate demand and supply model.
Multiple factors like capital, human capital, technology, and institutions play crucial roles in driving economic growth.