FE T9 - Economic Growth

Fundamentals of Economic Growth and Macroeconomic Concerns

  • Concerns of Macroeconomics: Macroeconomics focuses on three primary areas of concern for an economy:

    • Output Growth: The increase in the total production of goods and services.

    • Unemployment: The state of individuals being without work despite being available and seeking it.

    • Inflation: The general increase in prices and the fall in the purchasing value of money.

The Basics of Economic Growth

  • Definition of Output Growth: Output growth represents an increase in the aggregate output of an economy over a specific period, typically one year. Aggregate output refers to the total quantity of goods and services produced.

  • Measuring Aggregate Output: The standard measure for aggregate output is Gross Domestic Product (GDP). To allow for comparisons across different periods, economists use Real GDP, which is GDP calculated at fixed prices to adjust for inflation/price changes.

  • Economic Growth Rate: This is defined as the annual percentage change in real GDP.

  • Core Measurement Metrics: Economic growth and performance are measured using several related indicators, often reported in per capita (per person) terms:

    • Gross Domestic Product (GDP)

    • Net Domestic Product (NDP)

    • Gross National Product (GNP)

    • Net National Product (NNP)

    • Aggregate Income

Calculating Economic Growth Rates

  • Real GDP Growth Formula:     Growth of Real GDP=Real GDP in current year−Real GDP in previous yearReal GDP in previous year×100\text{Growth of Real GDP} = \frac{\text{Real GDP in current year} - \text{Real GDP in previous year}}{\text{Real GDP in previous year}} \times 100

  • Calculation Example:

    • Current Year Real GDP: RM8.4 trillionRM8.4\,trillion

    • Previous Year Real GDP: RM8.0 trillionRM8.0\,trillion

    • Growth rate=8.4−8.08.0×100=5 percent\text{Growth rate} = \frac{8.4 - 8.0}{8.0} \times 100 = 5\,percent

Standard of Living and Real GDP per Capita

  • Definition: The standard of living is heavily dependent on Real GDP per capita, which is real GDP divided by the total population.

  • Real GDP per Capita Growth Formula:     Real GDP per capita=Real GDPPopulation\text{Real GDP per capita} = \frac{\text{Real GDP}}{\text{Population}}

  • Per Capita Growth Comparison Example:

    • Current Year: Real GDP of RM8.4 trillionRM8.4\,trillion and population of 202 million202\,million. Real GDP per capita = RM41,584RM41,584.

    • Previous Year: Real GDP of RM8.0 trillionRM8.0\,trillion and population of 200 million200\,million. Real GDP per capita = RM40,000RM40,000.

    • Growth rate of Real GDP per capita=41,584−40,00040,000×100=4 percent\text{Growth rate of Real GDP per capita} = \frac{41,584 - 40,000}{40,000} \times 100 = 4\,percent

  • Relationship and Alternative Formula:     Growth of real GDP per capita=Growth rate of real GDP−Growth rate of population\text{Growth of real GDP per capita} = \text{Growth rate of real GDP} - \text{Growth rate of population}

    • Using the example above: 5 percent (GDP growth)−1 percent (Population growth)=4 percent5\,percent\,(\text{GDP growth}) - 1\,percent\,(\text{Population growth}) = 4\,percent.

    • Real GDP per person grows only if real GDP grows faster than the population. If population growth exceeds real GDP growth, real GDP per person falls.

The Rule of 70 and Sustained Growth

  • The Magic of Sustained Growth: Economic growth acts like compound interest. Sustained growth in real GDP per capita can transform a poor society into a wealthy one over time.

  • The Rule of 70: A mathematical approximation used to determine how many years it takes for a variable to double in size.     Years to double≈70Annual percentage growth rate\text{Years to double} \approx \frac{70}{\text{Annual percentage growth rate}}

  • Doubling Examples:

    • 2 percent2\,percent growth: 70÷2=35 years70 \div 2 = 35\,years

    • 4 percent4\,percent growth: 70÷4=17.5 years70 \div 4 = 17.5\,years

    • 7 percent7\,percent growth: 70÷7=10 years70 \div 7 = 10\,years

Compounding in Economic Growth

  • Compound Growth Method: Similar to financial savings, economic growth is multiplicative, where the growth rate is applied to a base that includes previous growth.

  • Future Value (FV) Formula for GDP:     FV=PV×(1+i)nFV = PV \times (1 + i)^n

    • PVPV = Original starting amount (Present Value of GDP per capita).

    • ii = Percentage growth rate (Interest rate).

    • nn = Number of years.

  • Numerical Scenarios (Starting at RM10,000 GDP per capita):

    • 3 percent3\,percent for 10 years10\,years: 10,000×(1.03)10=RM13,439.1610,000 \times (1.03)^{10} = RM13,439.16

    • 3 percent3\,percent for 20 years20\,years: 10,000×(1.03)20=RM18,061.1110,000 \times (1.03)^{20} = RM18,061.11

    • 4 percent4\,percent for 30 years30\,years: 10,000×(1.04)30=RM32,433.9810,000 \times (1.04)^{30} = RM32,433.98

The Business Cycle and Short-Run Fluctuations

  • Output Growth Concerns:

    • Short-run fluctuations: Short-term cycles of ups (expansion) and downs (recession) in aggregate output.

    • Long-run economic growth: The trend of output growth over many years.

  • Business Cycle Definitions:

    • Expansion: A period of output growth moving from a trough toward a peak.

    • Recession: A downturn characterized by declines in aggregate output for at least two consecutive quarters (6 months6\,months).

    • Depression: A deep and prolonged recession.

    • Trough: The lowest point of a business cycle.

    • Peak: The highest point of a business cycle.

  • Policy Goal: Policy makers attempt to 'fine-tune' the economy by smoothing fluctuations and minimizing the distance between peaks and troughs.

Global and Local Economic Comparisons

  • Selected 2013 Growth Rates (GDP current US$):

    • Indonesia: 5.80 percent5.80\,percent

    • Malaysia: 4.70 percent4.70\,percent

    • Philippines: 7.20 percent7.20\,percent

    • United States: 2.20 percent2.20\,percent (16.77 trillion16.77\,trillion GDP)

  • Long Run Growth (1993 - 2011) - Real GDP per person % change:

    • USA: 31 percent31\,percent

    • UK: 45 percent45\,percent

    • Norway/France: 22 percent22\,percent

    • Japan: 12 percent12\,percent

  • Malaysia's Productivity History: Average productivity levels (RM per worker) have grown from approximately 8,6188,618 in the 60s to over 36,38536,385 in 2011-2012. Competitive rankings show Malaysia at 15th in the IMD WCY 2013 report.

Sources of Economic Growth

Economic growth is driven by increases in inputs, categorized as endogenous (internal) and external elements.

  • 1. Labor Supply:

    • An increase in labor can generate more output.

    • Caveat: If the capital stock is fixed, adding labor leads to diminishing returns, making new labor less productive.

    • Labor Productivity: Measured as output per labor hour or output per laborer.

  • 2. Capital Stock:

    • Increases in equipment and structures (physical capital).

    • Growth in capital stock = Gross Investment - Depreciation.

  • 3. Human Capital:

    • The accumulated skill and knowledge of human beings.

    • Seen as a fundamental source of both labor productivity and technological advancement.

    • Acquired through education, training, and "learning by doing."

  • 4. Technological Change:

    • Occurs in two stages: Invention (advancement in knowledge) and Innovation (the actual use of knowledge to produce products more efficiently).

    • Includes new managerial methods and business organization forms.

External and Alternative Sources of Growth

  • Exogenous Factors: Those beyond a country's direct control.

    • External Economies of Scale: Global standardization (e.g., in electronics or ICT) that allows for mass production and cost savings.

    • Global Stability: Stability in global politics, stable oil prices, and advanced communication systems.

    • Natural Factors: The infrequency of natural disasters and famine.

Economic Growth and the Standard of Living

  • Growth increases productive potential. Living standards only improve if productivity increases (producing more goods/services per unit).

  • Mechanism of Improvement:

    1. Rising GDP yields more money in the economy.

    2. Businesses earn more profit.

    3. Businesses pay higher wages or hire more workers.

    4. Disposable income of households rises.

    5. Households purchase more goods/services.

  • GDP per capita PPP (Current International $) Rankings:

    • Qatar: $141,542.70\$141,542.70

    • Singapore: $85,382.30\$85,382.30

    • United States: $56,115.72\$56,115.72

    • Malaysia: $26,950.34\$26,950.34

    • Central African Republic: $618.75\$618.75

The Production Possibility Frontier (PPF)

  • Short-Run Concerns: Utilization of existing productive capabilities.

    • Points on the PPF curve (A, B, C): Represent full capacity and efficient resource use.

    • Point D (inside the curve): Represents underutilization, resulting in unemployment and waste.

    • Moving from D to the curve reduces unemployment but does not change potential capacity.

  • Long-Run Concerns: Expanding the country's productive capacity.

    • Large, lasting increases in output require the PPF to shift outward.

    • Expansion Drivers: Increases in production resources or advances in technology shift or pivot the PPF.

    • Economists use Gross Domestic Product (GDP) as a proxy to define changes in this potential output.

Macroeconomic Concerns

  • Output Growth: Increase in total production of goods and services.

  • Unemployment: Individuals without work but seeking jobs.

  • Inflation: General rise in prices and decrease in purchasing power.

Economic Growth Basics

  • Output Growth: Increase in aggregate output over a year.

  • Aggregate Output Measurement:

    • GDP: Gross Domestic Product.

    • Real GDP: GDP adjusted for inflation.

  • Economic Growth Rate: Annual percentage change in Real GDP.

Key Metrics

  • GDP

  • Net Domestic Product (NDP)

  • Gross National Product (GNP)

  • Net National Product (NNP)

  • Aggregate Income

Calculating Economic Growth

  • Real GDP Growth Formula:
    Growth of Real GDP=(Current Year GDP)−(Previous Year GDP)(Previous Year GDP)×100\text{Growth of Real GDP} = \frac{\text{(Current Year GDP)} - \text{(Previous Year GDP)}}{\text{(Previous Year GDP)}} \times 100

  • Example:
    Current: RM8.4 trillion
    Previous: RM8.0 trillion
    Growth Rate=8.4−8.08.0×100=5 percent\text{Growth Rate} = \frac{8.4 - 8.0}{8.0} \times 100 = 5\text{ percent}

Standard of Living

  • Dependent on Real GDP per Capita:
    Real GDP per capita=Real GDPPopulation\text{Real GDP per capita} = \frac{\text{Real GDP}}{\text{Population}}

The Rule of 70

  • Years to Double:
    Years to double70Growth rate\text{Years} \text{ to double} \frac{70}{\text{Growth rate}}

    • 2% Growth: 35 years

    • 4% Growth: 17.5 years

The Business Cycle

  • Expansion: Growth phase.

  • Recession: Decline for two consecutive quarters.

  • Depression: Extended period of recession.

  • Peak/Trough: Highest/lowest points in a cycle.

Global Economic Growth Rates (2013)

  • Indonesia: 5.80%

  • Malaysia: 4.70%

  • Philippines: 7.20%

  • USA: 2.20%

Sources of Economic Growth

  1. Labor Supply: More labor can increase output.

  2. Capital Stock: More equipment boosts productivity.

  3. Human Capital: Skills and education enhance productivity.

  4. Technological Change: Innovations improve efficiency.

Production Possibility Frontier (PPF)

  • Short-Run: Efficient use of resources vs. underutilization.

  • Long-Run: Requires outward shift for increased capacity.