1. AS Macro Revision
Economic Growth
Spring 2014

2. We add new resources / links / articles every day
to our Economics blogs
Follow this link for the AS Macro Blog on Tutor2u
www.tutor2u.net/blog/index.php/economics/categories/C59

3. What is Economic Growth?
• Growth is a long-term expansion of productive potential
• Short term growth is the annual % change in real national output
• Long term growth is shown by the increase in trend or potential
GDP and this is illustrated by an outward shift in a country’s long run
aggregate supply curve (LRAS)

4. Some of the Key Drivers of Economic Growth
Expanding the capital stock
Increasing the active
labour supply
Extracting and
selling natural
resources
Improving factor
productivity
Driving innovation
and enterprise
Economic
growth
“Structural reforms need to
be accelerated to improve
the UK economy’s skills
base, infrastructure, and
competitiveness.” (IMF,
June 2013)

5. Capital Investment and Economic Growth
Injection of demand for
capital goods industries
Bigger capital stock can lift
productivity / incomes
Economies of scale & better
competitiveness
Investment to sustain exportled growth

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7. Economic Growth using AD-AS
General
Price Level
LAS1
LAS2
AS1
AS2
GPL1
AD1
Y1
Yp1
Y2 Yp2
AD2
Increase in
productive
potential is shown
by an outward shift
of long run
aggregate supply
(LAS1 to LAS2)
This means a higher
level of aggregate
demand can now
be met because of
an increase in
supply capacity
Real GDP

8. Economic Growth using PPF Diagram
Output of
capital
goods
PPF2
A rise in a nation’s
productive capacity
causes the PPF to
shift out and this
allows increased
supply both of
consumer and
capital goods.
PPF1
B
A
C
D
Consumer goods

9. Some of the Benefits of Economic Growth
Higher living standards – i.e. Real GNI per capita –
helps to lift people out of extreme poverty
Employment effects - growth stimulates jobs and
contributes to lower unemployment rates
Fiscal dividend – higher economic growth will raise
tax revenue and reduce government spending on
unemployment related welfare benefits
The accelerator effect - rising growth stimulates new
investment e.g. In low carbon technologies. Better
relative growth may attract foreign direct investment

10. Is there a Virtuous Circle of Economic Growth?
Higher
national
output
(GDP)
Rising
consumer
demand
(C)
Increased
wages /
real
incomes
Increased
capital
spending
(I)
Increased
output
per head

11. Benefits from Growth driven by Technological Change
A rise in
productivity
• Increase in GDP per
worker
• Lower unit costs
• Higher wages
• Higher profits
New
Goods
and
Services
• Lower real prices
• Consumer welfare
gains (lower prices)
• Improved living
standards
Improved
health
• Healthy life
expectancy
• Labour force expands
• Increased productivity

12. We add new resources / links / articles every day
to our Economics blogs
Follow this link for the AS Macro Blog on Tutor2u
www.tutor2u.net/blog/index.php/economics/categories/C59

13. Costs of Economic Growth
High rates of GDP growth can bring about undesirable economic
and social costs – much depends on the nature of growth
Risks of higher inflation
• Fast-growing demand can lead to demand-pull and
cost-push inflation – which threatens macro stability
Environmental effects
• More negative externalities such as pollution & waste
• Risk of unsustainable extraction of finite resources
Inequalities of income and wealth
• Rapid increases in real national income can lead to a
higher level of inequality and social division

14. Economic Growth in China
China has experienced rapid growth over the last twenty years
helping to lift hundreds of millions of people out of deep poverty
• Real GDP growth in China has been 9.6% per annum since 1979
• 60-70% has come from increasing capital and labour inputs –
there has been a vast increase in capital investment spending
• 30-40% has come from rising total factor productivity growth (i.e.
From increasing efficiency in the allocation of resources)
• Looking at the increases in per capita output:
1. 11-15% from improving human capital
2. 8-15% from improving allocative efficiency (e.g. moving from
state-owned businesses to private and from rural to urban)
3. 16-17% has come from the productivity-enhancing effects of
innovation – much of which has been imitation of ideas

15. Growth Challenges for China in the Years Ahead
Chinese economic growth is slowing down towards
seven per cent a year. A weaker pace of growth for
China will have important effects on the world
economy – for example on prices of commodities
Chinese Reform Challenges
1. More reliance on their
own domestic market and
less on exports
2. Raise consumption and
reduce inefficient savings
3. Grow the private sector
and reduce distortions
from state-owned sector
4. Increase the pace of
innovation as imitation
limits are reached
5. Continue opening the
Chinese economy into the
global economic /
financial system. This
includes Chinese firms
going global

16. Growth Limiters in Developing Nations
Infrastructure Gaps
Export Dependency
Macro Instability
Conflict and Corruption
Human Capital Problems
Insufficient Savings
Natural Capital Depleted
Rising Inequality

17. Deficiencies in Human Capital as Barrier to Growth
Investment in education and training to increase the quality of the
labour force and make people more flexible in the labour market
Investment increases the size
of the capital stock and helps
to achieve “capital deepening”
(capital per worker) but
businesses need skills and
experience to make best use of
new technology
In many countries there are
acute shortages of human
capital
Human capital weakness
limits impact of investment
Some countries lose some of
its skilled workforce to other
countries through a brain drain

18. Savings Gaps: Importance of Savings and Investment
How a savings gap can limit
economic growth
•
•
•
In many smaller lowincome countries, high
levels of extreme
poverty make it almost
impossible to generate
sufficient savings to
provide the funds
needed to fund capital
investment projects.
This increases reliance
on tied aid
Some countries borrow
heavily to fund capital
investment projects –
this can lead to a high
level of external debt
Increase
national
savings
Increased per
capita
incomes
Rise in real
GDP / GNI
Increase in
net
investment
Larger capital
stock

19. Dangers from Primary Product Export Dependency
Conflict - risk of political conflict and corruption and rising inequality
Volatility - vulnerability to changes in world prices which causes high
levels of macro volatility – i.e. Trade imbalances, GDP growth
Sustainability - danger of over-rapid extraction of finite resources
Currency appreciation - makes exports of a developing country’s
manufactured products more expensive in overseas markets
Higher inflation - which hurts the real incomes of poorer groups who do
not directly benefit from resource exploration and production
Weak linkages - Resource extraction tends to be capital-intensive in
nature and often does not create a significant rise in new jobs

20. High Inflation as a Growth Limiter for India
High inflation close to 10% is widely seen as a major factor holding
back the growth of the Indian economy. It creates major problems.
Competitiveness and Exports
• Harder for Indian businesses to sell their goods and services
abroad, risk of FDI moving to other countries
• Higher inflation expectations can cause currency weakness
Business Investment
• Uncertainty about future costs and prices
• Businesses are more reluctant to invest in new projects
• Pressure for wages to rise causing higher unit labour costs
Inequality and social unrest
• Regressive effects of rising food and energy prices
• Poor tend to hold a larger proportion of their savings in cash, they
are the worst hit by accelerating prices

21. Economic Growth and Inequality
In many countries, a period of fast economic growth can lead to a
widening of inequality of income and wealth
“Half of one’s income depends on the average income of
the country in which that person was born.”
“8% of humanity takes home 50% of global income; the top
1% alone takes home 15%.”
“The richest 300 people on earth have more wealth than
the poorest 3bn - almost half the world's population.”
“Shared prosperity is defined as “fostering income growth
of the bottom 40% of the population in every country”
(World Bank, 2013).
Branko Milanovic, World Bank
economist and expert on
trends in global inequality
“Global inequalities are a lot higher than those within any
country of the world, including Brazil or South Africa, the
Gini-coefficient of the world is estimated at 0.70, while the
one of a country like Brazil is below 0.60.”

22. Some of the Key Causes of Rising Inequality
Tax system is
now less
progressive
Cognitive
elites and
rising incomes
Root Causes Of
Monopoly
rent seeking –
power elites
Market
failures in
education &
housing
Regressive
effects of high
inflation
Patchy state
welfare
systems
Widening
urban-rural
income divide

23. Get help on the AS
macroeconomics course
using twitter
#econ2
@tutor2u_econ
www.tutor2u.net