Economic Growth (DP IB Economics)
Revision Note
Short-term Growth
Economic growth can occur in the short-term or long-term and each is explained differently
Changes to any of the components of aggregate demand (AD) will cause short-term 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 curves model by moving from a point inside the curve to a point closer to the curve
1. Short-term Economic Growth on an AD/AS Diagram
Short-term economic growth through a shift of aggregate demand from AD→AD1
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-term growth has led to an increase in average prices from AP1→AP2
2. Short-term Economic Growth on a Production Possibilities Curve (PPC)
Short-term economic growth on a production possibilities curve (PPC) model
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-term Growth
Long-term 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
It can also be illustrated using the PPC model through a shift outwards of the entire curve
1. Long-term Economic Growth on an AD/AS Diagram
Long-term economic growth through an increase in the long-run aggregate supply (LRAS) of the economy
Diagram Analysis
A change to the quantity/quality of the factors of production has increased potential output of the economy from YFE→YFE1
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)
2. Long-term Economic Growth Using a PPC Model
The entire PPC of an economy can shift inwards or outwards thereby changing its production possibilities
An outward shift demonstrates long-term economic growth
Outward shifts of a PPC show long-run economic growth
Diagram Explanation
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 resources
This shift is caused by an increase in the quality or quantity of the available factors of production
One example of how the quality of a factor of production can be improved is through the impact of training and education on labour. An educated workforce is a more productive workforce and the production possibilities increase
One example of how the quantity of a factor of production can be increased is through a change in migration policies. If an economy allows more foreign workers to work productively in the economy, then the production possibilities increase
Calculating Economic Growth Rates
Economic growth is measured by calculating the change in the real GDP between two time periods (usually quarterly or annually)
The growth rate is expressed as a percentage
Several steps can be included in the calculation of an economic growth rate
Calculate nominal GDP from a set of data for two time periods
Calculate the real GDP for each time period using the GDP deflator
Calculate the percentage change in real GDP between the two time periods
Worked Example
Using the information provided in Table 1 and Table 2, calculate the economic growth rate for Vietnam [4]
Table 1
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Table 2
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103.8 | 107.2 |
Answer:
Step 1: Determine which of the data presented is relevant to the calculation
Nominal GDP = C + I = G = (X-M)
So income tax and net income are not relevant
Step 2: Substitute the relevant values into the GDP formula for 2018
Nominal GDP 2018 = C + I + G + (X-M)
Nominal GDP 2018 = 11255 + 8927 + 15697 + (8532 - 4957)
Nominal GDP 2018 = $39,454 billion
Step 3: Substitute the relevant values into the GDP formula for 2019
Nominal GDP 2019 = 11945 + 11100 + 16500 + (10300 - 3988)
Nominal GDP 2019 = $45,857 billion
Step 4: Calculate the real GDP for each year using the GDP deflator
Step 5: Calculate the real economic growth rate (the % change in real GDP)
(4 Marks for the correct answer or one mark for any correct work in the process. Final answer must be rounded to 2 decimal places)
Examiner Tip
Remember that an increase in the economic growth rate may not lead to inflation as the increase in economic growth may be caused by higher levels of aggregate supply which lead to lower average price levels.
Consequences of Economic Growth
Economic growth is considered to be the main contributor to an improvement in the standards of living
Due to the negative aspects of economic growth, there is much controversy about maintaining it as a central macroeconomic aim
Instead, arguments for a focus on societal well-being are gaining traction
An Evaluation of Economic Growth
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Living standards |
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The Environment |
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Income distribution |
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Examiner Tip
In the Paper 2 data response material, you may see the phrases 'at constant prices' or 'at current prices'. 'Constant prices' refers to price levels which have been adjusted for inflation whereas 'current prices' refers to nominal price levels.
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