Economic growth

Economic growth

• the increasing capacity of the economy to satisfy the material wants of its members.

• most important macroeconomic objective because it determines the future 'opportunity set' of the economy and enables households to a achieve higher standard of living in material terms.

Sustainable economic growth

rate of economic growth that increases standards of living without compromising standard of living and resources for future generations

Measuring economic growth

• through rate of change of GDP (final market value of all the goods and services produced in an economy over a period of time, usually a year).

• this shows rate of economic growth and describes the rate at which material welfare is rising - how fast the production possibility curve is shifting to the right

GDP

Measure of the value of output produced but doesn’t necessarily tell us about the broader standard of living or the level of welfare of people in the community

Nominal GDP

adjusted to remove the effect of price increases (inflation). Over time, real GDP tells us what the value of output is worth as if there had been no price changes in the economy, thus it is more useful for comparing different time periods. 

Real GDP

is the value of output expressed in the prices of the day (current prices) 

Calculating real and nominal GDP

• e.g. 250→ 290 billion nominal GDP, and price index 100→110 from 2020 to 2022. Find the GDP of 2022 in 2020 terms.

• Price index shows an increase in prices by factor 1.1

• 290 billion GDP in 2022 is nominal- bears price increase of factor 1.1

• To find the real GDP in 2022 terms- remove price increase of factor 1.1

• Answer= 290/1.1= 264 billion

GDP rate statistics

• annual growth rate is sum of the previous four quarters.

• ABS and RBA often release quarterly growth rates.

• the average rate of economic growth in Australia since 1960 is 3.4%

• however, the average rate of economic growth in Australia since 2000 has slowed to 3.0%

GDP per capita

• Allows us to compare material welfare to other countries (e.g. India has a greater GDP with larger population, labor and demand, but GDP per capita is lower than Australia’s GDP per capita: the average Australian is better off than the average Indian).

• GDP/ population

• Real GDP per capita increased 1.9 times since 1980, meaning that the average Australian is 1.9 times better off now than they were in 1980.

• for people to be better off in material terms, economic growth has to be faster than population growth.

Limitations of using GDP as a measure of welfare

• Income distribution

• All aspects of welfare

• Quality of products

• Real working conditions

• Accounting for economic “bads” as well as “goods”

Income distribution

• economic growth and higher GDP per capita should bring a higher standard of living BUT not everyone’s welfare has increased because distribution of economic growth’s benefits is unevenly spread.

People benefiting the most from GDP growth

1. Owners of non-labor resources: (land, capital, enterprise) because the demand for these scarce resources increases as the economy grows, so they capture most of the extra income through rent, interest, and profits

2. Workers in growing sectors of the economy; economic growth isn’t uniform across all industries so workers in expanding industries experience higher demand for their skills, higher wages, better security BUT workers in shrinking industries experience unemployment or stagnant wages.

   (e.g. technology expands rapidly vs traditional retail may stagnate or shrink due to online shopping),

3. Workers who are occupationally mobile (able to switch jobs or learn new skills) and geographically mobile (able to move to where jobs are like big cities); when the economy grows, new opportunities cluster in certain regions and industries, so workers who can adapt skills or relocate are better positioned to take advantage of these opportunities, so they benefit more.

Doesn’t account for all aspects of welfare

• Some types of economic activity that add to the material welfare of society because they satisfy our wants, but they aren’t assigned monetary value or recorded/estimated because there isn’t an exchange of goods/service for payment→ not included in GDP

• Hence, GDP understates the true value of production in our economy.

Examples of nontraded goods:

• housework

• charity work

• voluntary work

• DIY jobs

• 'cash' or underground (illegal) activities

Working conditions

• productivity has risen slowly as knowledge and skills in human capital rises + more capital equipment is used in production → ceteris paribus, rising productivity should allow more leisure time and better conditions

• BUT if growth is the result of working overtime/2 jobs then the risen material welfare may not be worth the costs of achieving it

• national accounts don’t report on working conditions e.g. demanding rosters for FIFO workers, suicide nets for Foxconn buildings in China

Quality of products

GDP does not account for the changes in quality or utility of goods produced over time. Current versions of household electronic equipment deliver much better performance than 2009 models, for example.

Economic bads and goods

GDP only measures flow of output and income e.g. economic goods (goods with benefit/utility to consumer/ society), not the impacts of them e.g. economic bads (gives negative utility, negative effect to the consumer)

Economic growth comes with a significant environmental cost that isn’t measured by GDP:

• pollution

• loss of biodiversity

• resource depletion

• climate change

Impact of economic growth

• levels of output and material welfare increase if economic growth happens. If an economy has higher growth p.a., they will reach increased levels of output and material welfare than it could with a lower growth p.a.

  So, current growth rates affect future production and consumption possibilities.

PPF

shows all the combinations of output an economy can produce at the current time, given resources and technology stay the same

Higher productivity, often driven by technological innovations, improved resource quality (like education), or increased resource quantity (labor, capital), allows for more output from the same inputs→ PPF shifts outward because economy can now produce a greater quantity of all goods and services.

The opportunity cost of focusing on capital: lower standard of living now compared to consumer goods which improve quality of live/ standard of living now

Aggregate Production Function

• relates total output of economy to total employment in economy, ceteris paribus (all other determinants (capital, land, technology) remaining unchanged)

• economy operating at the aggregate production function is producing the potential level of output

• shape shows that in an economy, as employment increases, output increases, but at a decreasing rate

  (diminishing marginal returns)

Diminishing marginal returns in the economy

Diminishing marginal returns occur when additional units of a variable factor add less and less to total output, given constant quantities of other factors. Example 1**:** Increasing employment from 120 million to 130 million, increases output by $500 billion to $12,000 billion at point B. The next 10 million workers increase production by $300 billion to $12,300 billion at point C. Shows diminishing marginal returns.

Example 2: firm can increase output by hiring more workers, but because the technology and capital are fixed, the firm’s capital per worker falls as each additional worker adds less and less output. So, like the firm, the economy also experiences diminishing marginal returns