Economic Growth and Theories

Potential output/GDP

The maximum sustainable level of output that the economy can produce.

Potential output/GDP

This is the highest level of production an economy can maintain indefinitely without causing harmful side effects, such as rampant inflation or overuse of resources.

PPF (Production Possibilities Frontier)

he maximum quantity of goods that can be efficiently produced, given available technology and inputs.

PPF (Production Possibilities Frontier)

This boundary represents the best an economy can do with its existing resources. To achieve economic growth, the PPF must physically shift outward.

Economic Growth

Involves the expansion of a country’s potential GDP or national output over the long run.

Economic Growth

This simply means a country is able to produce more goods and services over time, leading to rising average incomes and improved living standards.

Human resources

• Four Fundamental Factors Driving Economic Growth

• Includes the size of the labor force and the quality of workers (education, skills, discipline)

Natural resources

• Four Fundamental Factors Driving Economic Growth

• Examples are oil and gas, as well as soils and climate.

Capital stock

• Four Fundamental Factors Driving Economic Growth

• This includes physical assets like homes, factories, and machinery, as well as intellectual property and social overhead capital.

Technology and entrepreneurship

• Four Fundamental Factors Driving Economic Growth

• This factor involves the quality of scientific and engineering knowledge, managerial know-how, and rewards for innovation.

 Q=A⋅F(K,L,R)

The level of national output (Q) is represented by the formula

Q

• Level of national output

• The total amount of goods and services produced.

F(K, L, R)

• A function of the level of productive services of capital (K), labor (L), and natural resource (R) inputs.

• The inputs necessary for production (machinery, workers, and land/resources).

A (Technology)

• Augments the productivity of inputs (produce more output with same level of inputs).

• This factor represents the efficiency and knowledge used in production; better technology allows you to get more output from the same amount of inputs.

3/4

labor

1/4

capital

Productivity

• Ratio of output to weighted average of inputs.

• A measure of efficiency—how much a worker or machine can produce in a given time.

Classical Models (Malthus’s Dismal Science):

• These models emphasized land and population as the most important factors, often resulting in a stable equilibrium at subsistence wages.

• Theories of Growth

Neoclassical Growth Model (Solow):

• This model focuses on capital accumulation (capital deepening) as the driver of growth.

• The prediction is that growth stops when the economy reaches a steady state (V), where capital per worker (K/L) is constant, output per worker (Q/L) is constant, and real wages stop growing.

K/L

Capital per worker

Q/L

Output per worker

1. Capital Per Worker is constant (K/L)

2. Output per worker is constant (Q/L)

3. Real Wages Stop growing

• When does the growth of the economy stop and reaches a steady state according to the Neoclassical growth Model

New Growth Theory

This theory recognizes that in the real world, living standards have not stagnated.

It posits that economic growth is primarily the result of endogenous (internal) forces.

Technological change (TC)

in the new growth theory ______, is viewed as an output of the system, generated through investment in human capital, innovation, and knowledge. Since TC is a public good, it is subject to market failures.

1. Growth in Labor

2. Growth In capital

3. Technological Chanfe

Growth accounting decomposes the growth in output into three terms:

Fundamental equation of growth accounting (assuming a competitive economy where labor share is ¾ and capital share is ¼) is:

total factor productivity

TC is also called the growth of

In this model, TC is calculated as a "residual", meaning it is the portion of output growth that cannot be explained by measurable increases in labor or capital

Productivity growth

• (when output grows faster than inputs)

• is a vital measure of economic performance.

growth

focusing on market incomes

development

focusing on outcomes and progress

1. Low per capita income

2. poor health

3. low levels of literacy

4. malnutrition

5. weak institutions (both market and government).

Developing countries are often marked by

Human Capital:

Quality of education, malnutrition, and poor health.

• Characteristics of Developing Countries:

Natural Resources:

•  The "Resource curse," where mineral wealth is not converted into productive capital.

• Characteristics of Developing Countries:

Physical Capital:

• Too little saving, leading to insufficient investment in social overhead capital (infrastructure).

• Characteristics of Developing Countries:

Low average incomes → Low saving and investment → Low pace of capital accumulation → Low productivity → Low average incomes.

The difficulties in combining the four growth elements (human resources, natural resources, capital stock, technology) reinforce each other in a vicious cycle of poverty.