Section 1: Why Is Economic Growth Important?

Small differences in growth can equal big differences over time due to the power of compounding.

Cammeraydave/Dreamstime.com

Economic growth is the most important factor influencing a country’s standard of living. Economic growth is measured by a nation’s ability to increase real GDP and real GDP per capita. Using real values instead of nominal values allows a country to compare growth from year to year without having to take into account the effects of inflation. Countries with high economic growth have seen rising incomes and better lives for their citizens.

The Rule of 70 is a simple tool used to estimate the number of years needed to double a value given a constant growth rate.

Number of years = 70 / growth rate

Examples: Number of years to double at growth rate of:

1% = 70/1% = 70 years

2% = 70/2% = 35 years

5% = 70/5% = 14 years

10% = 70/10% = 7 years

20% = 70/20% = 3.5 years

In 28 years, the initial $1,000 is worth $16,000 at 10% growth versus $4,000 at 5% growth.

Section 2: Thinking About Short-Run and Long-Run Economic Growth

Short-Run Versus Long-Run Growth

Short-run growth occurs when an economy makes use of existing or underutilized resources, and is shown as a movement from inside a PPF toward the PPF (such as from point a to point b).

Long-run growth requires an expansion of production capacity through an increase in resources or technology, and is shown by a shift of the PPF (such as from PPF_A to PPF_B).

A production function is the method by which firms turn factors of production into goods and services.

Lou Linwei/Alamy

Factors of Production

• Land (N): includes land and natural resources
• Labor (L): within labor is human capital (H), labor improved by education or training
• Capital (K): manufactured goods used in the production process
• Entrepreneurial ability (A): ideas and technology

Section 3: Applying the Production Function: Achieving Economic Growth

Productivity is the ability to turn a fixed amount of inputs (factors of production) into more outputs (goods and services).

Ways to Increase Productivity

Rising productivity leads to growing incomes and a better standard of living.

© Molimar/Dreamstime.com

• Increasing access to natural resources
• Improving quality of labor (human capital)
• Increasing the capital-to-labor ratio
• Promoting innovation and technology

Total factor productivity is a measurement of productivity taking into account all other factors other than the quantity and quality of inputs that could influence production. Examples include natural disasters, climate, or cultural norms that influence the effectiveness of productive inputs.

Section 4: The Role of Government in Promoting Economic Growth

The government can promote economic growth by investing in physical capital, human capital, and technology.

Government involvement in promoting economic growth occurs by way of:

The Index of Economic Freedom ranks 184 nations in terms of overall environment for promoting economic growth. In 2013, Hong Kong ranked first, and the United States came in tenth.

Jake Wyman/Corbis

• Physical capital: The building and maintenance of the country’s public capital (infrastructure), which includes roads, bridges, airports, power plants, and telecommunications networks.
• Human capital: Providing subsidized public college education, financial aid grants and loans.
• Technology: Funding research and development, and the establishment of major government research labs.

West Point, the United States Military Academy, is an example of government promoting physical capital (the campus and buildings), human capital (education), and technology (research by its faculty).

Ted Spiegel/CORBIS

Government As a Guarantor of Economic Growth

• Enforcement of contracts: A strong legal system.
• Protection of property rights: Ensuring that monetary rewards are provided to innovators.
• Stable financial system: A functioning and stable monetary system ensures investment is undertaken when the opportunity arises.
• Promoting free and competitive markets: International trade allows for specialization and gains from trade, and competitive markets ensure firms do not exploit market power, their ability to set prices for goods and services in a market.