economic-growth

The Distinction Between Short-run & Long-run Economic Growth

• Economic growth can occur in the short-run or long run, and each is explained differently
   

• Short-run growth is growth that occurs as a result of using existing resources more efficiently

  • Short-run growth is usually driven by changes in aggregate demand and is referred to as demand-side growth

  • Short-run growth can also be driven by changes in the factors that influence short-run aggregate supply, leading to supply-side growth

• Long-run growth occurs when there are sustained improvements in the quantity or quality of the factors of production, leading to an increase in the production of goods and services over a period of time

  • This growth is driven by factors such as technological advancements, investment in human capital, capital accumulation, institutional and policy factors, population growth, and research and development

Causes of Short-run Economic Growth

Short-run demand-side growth

• Changes to any of the components of aggregate demand (AD) will cause short-run economic growth to occur 

  • Demand-side growth can be illustrated by using the production possibilities curves model. Growth occurs when there is a movement from a point inside the curve to a point closer to the curve

  • Demand-side growth can also be illustrated on an AD/AS diagram through a rightward shift in AD

Diagram: Short-run Economic Growth on a PPC)

Diagram analysis

• Economic growth in the short run involves using more of the available resources (the factors of production)

• As the economy is operating below full potential, there is spare capacity available 
  If the economy is operating inside the curve, there is room for growth without the need for additional resources

  • This is seen as movements within the Production Possibilities Frontier 

• An increase in output has caused a shift in production combinations from X→Y

  • The current real output has increased, moving closer to the maximum possible output of the economy

    •  This represents an increase in real GDP

    • An increase in real GDP = economic growth
       

Diagram: Short-run Economic Growth using AD/AS 

Diagram analysis

• An increase in consumption, investment, government spending or net exports has caused a shift in AD from AD →A D₁

• The current real output has increased from Y₁ → Y₂ which represents an increase in real GDP

  • An increase in real GDP = economic growth

• This short-term growth has led to an increase in average prices from AP₁ → AP₂

Short-run Supply-side Growth

• Short-run supply side growth is caused by anything that shifts the SRAS curve in an economy

  • E.g. A fall in the costs of production, a decrease in taxes, or an increase in the level of subsidies

  • It effectively creates a condition of excess supply in the economy

  • Average price levels fall

  • National output (rGDP) increases 

Diagram: Short-run Supply-side Growth

Diagram analysis

• The initial macroeconomic equilibrium is at AP Y

• Any factor which causes an increase in the SRAS will result in the SRAS curve shifting right from SRAS → SRAS₁

• This shift causes a fall in average price levels from AP → AP₁

• The new macroeconomic equilibrium is now at AP₁ Y₁

• Short-run supply-side growth has occurred

Causes of Long-run Economic Growth

• Long-run economic growth is caused by any improvements to the determinants of long-run aggregate supply

  • This is illustrated on an AD/AS diagram by a rightward shift in the LRAS

  • This represents a change to the normal production output of an economy

Diagram: Long-run Economic Growth Using AD/AS

Diagram analysis

• A change to the quantity/quality of the factors of production has increased potential output of the economy from Y_FE→Y_FE1

  • E.g. More rigorous competition policy creates a higher number of firms in each industry, leading to greater aggregate supply in the economy

    • This shifts the long-run aggregate supply curve to the right (LRAS1→LRAS2), resulting in economic growth

• The final impact on price levels depends on the shape of the long-run aggregate supply curve (Keynesian or Classical)

• Long-run economic growth can also be illustrated using the PPC model through a shift outwards of the entire curve 

• The entire PPC of an economy can shift inward or outward, thereby changing its production possibilities

• An outward shift demonstrates long-term economic growth

Diagram: Long-term Economic Growth Using a PPC

Diagram analysis

• Economic growth occurs when there is an increase in the productive potential of an economy

  • This is demonstrated by an outward shift of the entire curve

  • More consumer goods and more capital goods can now be produced using all of the available re