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AP®︎/College Macroeconomics
Course: AP®︎/College Macroeconomics > Unit 5
Lesson 6: Economic growthUnderstanding economic growth
Economic growth is an expansion of the capacity to produce, not just a temporary fluctuation in GDP. In this video, learn about the definition of economic growth and how growth occurs.
Want to join the conversation?
- So does it mean that the rise of full employment level cause economic growth?(4 votes)
- When the full employment level of output increases it doesn't cause economic growth, it is economic growth. Economic growth is an increase in capacity. If the capacity of the economy increases (for example, because there is more capital or more human capital), then the potential output of an economy increases.(5 votes)
- Is the "full employment growth" concept here the same as "Potential GDP/output"?(1 vote)
- Full employment output is the same as potential output.
Growth is growth.(5 votes)
- So what would be an example scenario if the employment level is increasing while GDP is decreasing at a certain period in time?(2 votes)
- How govt measure full economic growth, how they decide for next year some x% of increase should be there in full economic growth, because it depends on like increase in workforce, change in technology etc, and their impact on productivity also matters suppose workforce increased by 1% in one year but we don't know how much productivity that will increase.(1 vote)
Video transcript
- [Instructor] In this
video we're going to talk about economic growth, and I wanna 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 gonna
call that an expansion, not necessarily economic growth. And we're gonna 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 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, call it t sub one. So right at this point, that is our full employment output. Let's call it y sub f sub one. 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 t two. So let's go to sub two here. Because the y sub f right over here, the full employment output
right over here is flat, according to this we
would not have experienced any economic growth from
t sub one to t sub two, even though the real GDP would have grown. We would've grown from
this point to this point right over here. So one way to think about it is, 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 were and were able to plot it 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 a production
possibilities curve. The ones that we typically see only have two goods or services. A real economy's gonna
be much more complex. It would have millions
of goods and services, but it's very hard to
draw a million-dimension production possibilities curve. But 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. 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 curve out. This is an example of economic, economic growth. So for example, this could be our production
possibilities curve at let's say t three where this is t sub three right over here, and then this is our
production possibilities curve at t sub four, where this is t sub four 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 studied that, we saw that in the short-run, because of say 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, or 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 t three, 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 t four. So this is full employment
output let's call that sub three. This would be full
employment output sub four. 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. There's 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 could 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.