causes-of-growth

Causes of Economic Growth

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

Short-run economic growth

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

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

  • It can also be illustrated by using the production possibilities frontier model by moving from a point inside the curve to a point closer to the curve

1. Short-run economic growth on AD/AS diagram

Diagram analysis

• An increase in consumption, investment, government spending or net exports has caused a shift in AD from AD→AD₁

• 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-run growth has led to an increase in average prices from AP₁→AP₂

2. Short-run economic growth on Production Possibilities Frontier (PPF)

Diagram analysis

• An increase in production 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

Long-run or potential economic growth

• Long-run economic growth is caused by any improvements to the quality or quantity of the factors of production

  • These factors include all of the determinants of long-run aggregate supply

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)

Actual & Potential Growth

• Actual economic growth occurs when there is an increase in the real value of goods and services produced in an economy over a given period of time

  • This is measured by the percentage change in real GDP, which accounts for inflation and reflects changes in both the quantity and value of output

• Potential growth is the increase in the productive potential of an economy as demonstrated by a shift outward of the production possibilities frontier (PPF) or the long-run aggregate supply (LRAS) curve

• At any given point in time, the actual economic growth may be less than the potential growth available to the economy

International Trade & Export-led Economic Growth

• International trade is an important source of income for many countries

• Export-led economic growth refers to growth that occurs as a result of an increase in the sale of goods/services to foreign countries

  • Net exports (X-M) is a component of aggregate demand (AD)

  • For many developing countries, the exports represent a high percentage of the annual AD and gross domestic product (GDP)

    • When the value of the exports rise, the real GDP rises significantly – and vice versa

• E.g. China experienced significant export-led economic growth from 1988 to the global financial crisis of 2008