Economic growth: We’re going to talk about economic growth and I want to be very careful here because depending on the context people including economists might mean different things by economic growth in everyday language.
When people are talking about economic growth they’re usually just talking about an expansion in the output of an economy over time so if real GDP is increasing they might consider that to be economic growth but the context that we’re going to talk about in this video and this is one that you might see in an introductory economics class or an ap economics class we aren’t just talking.
About an increase in real GDP over time we are talking about an increase in the full employment output over time regardless of where we are in the economic cycle so keep that in mind as you watch this video if we’re just talking about the increase of real GDP we’re going to call that an expansion, not necessarily economic growth.
Economic growth Microeconomics
We’re going to call real GDP decreasing as being equal to a contraction when we talk about economic growth we’re actually talking about the full employment output increasing and this could happen somewhat independently of where we are in the actual economic cycle let’s do a little diagram to make that a little bit clearer so right over here.
I have plotted the real GDP of an economy versus time and what you see here in yellow is how the real GDP is fluctuating and it’s fluctuating around its full employment output let’s pick this time right over here and call it t sub 1. so right at this point that is our full employment output let’s call it y sub f sub 1. but we see that our economy is performing above our full employment output.
We have a positive output gap if we go from that point in time fast forward a little bit to t2 so let’s go to t sub 2 here because the y sub f right over here the full employment output right here is flat according to this we would not have experienced any economic growth from t sub 1 to t sub 2 even though the real GDP would have grown we would have grown from this point to this point right over here so one way to think about it.
Economic growth Pros
We are expanding as long as this curve is upward sloping but if the full employment output is not changing we are not experiencing economic growth the times where we actually are experiencing economic growth are times where our full employment output is changing so let’s say from this time right over there to this time right over there and notice that is happening theoretically during a contraction this is a contraction right over here where real GDP is actually pulling back but if we knew truly what the full employment output was and was able to plot.
It is like this theoretically we actually are experiencing economic growth here despite a contraction to appreciate this let’s look at other models that we have studied in economics so we think about the production possibilities curve the ones that we typically see only have two goods or services a real economy is going to be much more complex.
Important Things To Know
It would have millions of goods and services but it’s very hard to draw a million dimension production possibilities curve what this shows us is at a snapshot in time what is the full employment output and it shows us the trade-off between these two goods or services now if we’re in a situation where we’re behind the production possibilities curve that is a negative output gap and it’s possible that over time we go from this negative output gap back to the production possibilities curve that would be an expansion in the economy but by the definition that we’re talking about here which is not what is typically talked about in the news or something like this we would not call.
That economic growth happens when we push out the production possibilities curve when we have an increase in our full-employment output so economic growth is maybe through some new technology or some more workers or resources or just better institutions we’re able to push our production possibilities to curve out this is an example of economic growth so, for example, this could be our production possibilities curve at let’s say t3 where this is t sub 3 right over here and then this is our production possibilities curve at t sub 4.
Where this is t sub 4 right over here where our full employment output has increased we can also think about the same idea using our aggregate demand or aggregate supply model when we study that we saw that in the short run because of saying a demand shock or a supply shock we could be operating to the left or the right of our full employment output creating these positive or negative output gaps but over time we’re going to gravitate back to this full-employment output and so as long as our production possibilities curve isn’t getting pushed out isn’t changing.
As long as our long-run aggregate supply curve is not changing according to the definition that I’m talking about in this video we are not seeing economic growth the analog for what we saw in this PPC curve is maybe this is the long-run aggregate supply curve at t3 but if our economy has more resources maybe more population more natural resources better technology better institutions maybe it’s able to produce more at full employment and in that situation our long-run aggregate supply curve would shift to the right and so this could be our long-run aggregate supply curve at time t4 so this is full employment output let’s call that sub 3 this would be full employment output sub 4.
Economic growth Conclusions
The big takeaway here is regardless of where we are in the expansion or contraction of our business cycles the economic growth is the change in that blue line and if we’re looking at the PPC it’s a shift out of our PPC of our production possibilities curve if we’re looking at the aggregate demand aggregate supply model it is a shift to the right of our long-run aggregate supply curve and once again what are the things that can cause that and these are good to know a notion of capital traditionally people have just thought hey more factories more resources more land maybe.
That will push things out and it definitely could but more modern definitions are thinking human capital hey if we have a better educated workforce a more skilled workforce that can also matter people also think about things like technology if we can discover better ways of putting together the resources we have that can also increase our productivity and that’s what we would call technology in an economics context and things like institutions matter as well you could imagine if your bureaucracy is really slows things down if it takes forever to get a permit to do something well that might put a hamper on what the full employment output is but if the institutions become much more efficient well then that might allow the country allow that economy to produce more at full employment so all of these things could push out your PPC could push your long-run aggregate supply curve to the right or cause this blue curve which represents your full employment output to move up over time all of that would be economic growth