Economic Growth Notes

Economic Growth

Measuring Economic Growth

• Real GDP per capita is a key measure of the standard of living, calculated as: $y = \frac{\text{Output}}{\text{Population}} = \text{Output per worker} \times \text{Proportion of population working}$
• Economic growth can occur by:
  • Increasing the proportion of the population that is working.
  • Increasing productivity (output per person).

Production Function

• Shows the relationship between GDP and hours worked, holding technology, capital (physical and human), and land constant.
• Law of diminishing returns: Each additional hour of labor adds less to GDP than the previous hour.
• Increased productivity shifts the production function upwards, allowing more GDP per hour worked.
  • Driven by increased capital and technological advancements.

Labor Productivity

• Two components:
  • Capital deepening: Using more capital per worker.
  • Total factor productivity: Technological changes and innovation.
• Increased output is a result of:
  • More labor.
  • More capital.
  • Technological improvements.

Sector Impact

• Labor productivity varies across different economic sectors.
• Agriculture tends to have lower GVA (Gross Value Added) per hour worked compared to sectors like information technology.

Importance of Productivity

• Higher productivity leads to:
  • Higher income.
  • Cheaper and better goods/services.
  • More leisure and work options.
  • Increased funds for social and environmental goals.
• Real wages grow faster in high productivity growth industries.

Economic Composition

• Developed economies typically see a shift from agriculture to manufacturing and then to services.
• Increase in the service sector may contribute to declining productivity growth due to challenges in boosting service productivity.

Drivers of Economic Growth

• Economic freedom and property rights create the right conditions for growth by providing incentives.
  • Protection of private property encourages investment.
• The easier it is to create firms, the more opportunities there will be for growth.
• A monetary exchange system facilitates specialization and trade.

Factors Determining Growth Rate

• Physical capital: More resources for workers increase labor productivity.
• Human capital: Knowledge and skills enhance labor productivity.
• Technological advance: Research, development, and innovation drive growth.

Government Policies for Growth

• Encourage saving and investment through tax incentives.
• Fund basic research because individual firms may not be able to capture the full benefits.
• Promote international trade to benefit from specialization.
• Improve the quality of education focusing on skills like maths.

Unemployment

• Unemployment impacts the economy negatively, as potential GDP is measured when all resources are fully employed.
• Unemployment rate: Percentage of the labor force that is unemployed.
  • Rising unemployment often results from policies to dampen the economy and curb inflation.
• Definition: Individuals not employed, available to work, and actively seeking employment.

Broader Measures of Labor Underutilization

• Underutilization includes:
  • Unemployment.
  • Underemployment (wanting more hours).
  • Potential labor force (job seekers unavailable or discouraged).
• Underemployed: People working part-time but wanting more hours.
• Potential labor force: Individuals meeting some but not all criteria for unemployment, including discouraged workers who have stopped seeking employment.

Impact of Labor Underutilization

• Lost income reduces consumption and GDP.
• Lost productivity reduces GDP.
• Loss of human capital, especially with long-term unemployment.