What is Economic Growth?

How do we know when we are better off?

What is our aim as consumers?• Satisfy our wants and needs• We do this through purchasing goods and

services• Goods and services gives us satisfaction (called

utility) • e.g. Purchasing food to satisfy

our hunger

• We make the assumption that we gain more satisfaction when we have more goods and services

• So the more goods and services the economy produces the better off we will be

• Economic growth = When the economy produces more goods and services

Productive Capacity

Net SocialWelfare

RealIncome

EconomicGrowth is anIncrease in

Economic growth as an increase in real income

• GDP is a measure of national income

• Gross domestic product= dollar value of the production of goods and services produced in an economy in a year

• An economies standard of living is measured by the number of goods and services that it has available to use and enjoy. Thus if GDP has risen (there has been an increase in the amount of goods and services produced) an economies standard of living would have risen also as well as economic growth.

Growth as increased Social Welfare

• Net social welfare takes into account factors other than material wealth.

• Net social welfare = Economic welfare + non-economic welfare

• Indicators of non-economic welfare include: – Population– Birth rate– Death rate– Life expectancy– Infant mortality– Density of population

Growth as increased Social Welfare

Net Social Welfare (EXAMPLE)

An EconomyEconomic Welfare

- More cars and material possessions

Non-Economic Welfare

- But there is congestion, pollution and not enough time to enjoy these things.

NET SOCIAL WELFARE

- But overall are people better off than they were in the Past?

Growth as increased Productive capacity

• Is the potential of a Nations resources, i.e.:– Everyone has a job– All factories, shops are working to their potential– All land and sea activities are in use

• Increasing capital formation (investment) means that the economy is able to produce greater quantities of goods and services – Stocks of capital goods must have increased

• INVESTMENT

• Gross Fixed Capital Formation – Depreciation = Net Fixed Capital Formationmeans you must be replacing worn out capital plus some.

Growth as increased productive capacity

Questions

1. Plot gross fixed capital formation, net fixed capital formation and consumption of fixed capital on a multi line graph ( one graph 3 lines)

2. Describe the trends you observe

3. Give an example of capital formation of (a) private (b) central govt (c) local govt

4. What factors might be causing the changes in gross fixed capital formation by the private sector and the public sector?

HDI index• The HDI index is one way of attempting to

utilise the Net Social Welfare definition of Growth.

• It takes into account three separate idea’s:– Long and healthy life (life expectancy index)– Education and Knowledge (adult literacy rate

and gross enrolment ratio= Education index)– A decent standard of living (GDP index)

• HDI index = 1/3 (Life expectancy index) + 1/3 (Education index) + 1/3 (GDP index)

Measuring Economic Growth

• GDP= P x Q

• Gross domestic product is the quantity of goods and services multiplied by the price paid for each unit.

Measuring GDP: ExampleQuantity of Pizzas

Price of pizzas

Quantity of pies

Price of pies

2000 10 $10 15 $5

2004 20 $12 30 $6

Imagine the economy only produces pizzas and pies.

Calculate GDP in year as the market value of production

GDP 2000=(10pizzasX$10/pizza) +(15piesX$5/pie)=$175

GDP 2004=(20pizzasX$12/pizza) + (30piesX$6/pie)=$420

Looking at these two GDPs what would you conclude?BUT

Looking closely you can see the quantities produced of pizzas and pies in 2004 are twice that produced in 2000

If eco activity exactly doubled why do the calculated values of GDP show a greater increase?

Prices as well as quantities rose!

Real Vs Nominal GDP

• GDP= PXQ -what we call ‘nominal GDP’.• Nominal Values are calculated using current

prices. These prices do not have the effects of inflation or price changes removed.

• Inflation =

• These values cannot be meaningfully compared from year to year

Increase’s in the price level

Real GDP• Real GDP is slightly different to nominal in that inflation is

taken into account

• Calculated using constant prices. – prices used for one year is used to calculate values for all years

• Can be meaningfully compared from year to year

• Real Income= Nominal GDP (year x) Price index (year x)

• Definition

• GDP = nominal GDP with the removal of the distortion caused by increasing prices (inflation)

Measuring Economic Growth

• Rate of economic growth = Real GDP (year 2) –Real GDP (year1)

Real GDP (year 1) X 100

Real GDPQuantity of Pizzas

Price of pizzas

Quantity of pies

Price of pies

2000 10 $10 15 $5

2004 20 $12 30 $6

Using the data in the table above and assume year 2000 is the base year find real GDP for years 2000 and 2004

How much did real output grow between 2000 and 2004

Year 2000 real GDP=(10pizzasX$10/pizza) +(15piesX$5/pie)=$175

Year 2004 real GDP=(year 2004 quantity pizza's X year 2000 pizza prices) + (Year 2004 quantity pies X year 2000 pie prices)

= (20X$10) + (30X$5)

=$350

By using real GDP we have eliminated the effects of price changes and obtained a reasonable measure of actual change in physical production

Growth 350-175/175 X 100 = 100% growth

A comparison of Real GDP growth : NZ and the OECD

During the 1980s NZ was well behind the OECD in its rate of economic growth.

But NZ has now managed to achieve growth rates in excess of the OECD average since that time.

International Comparisons

• Is it fair that we compare NZ’s GDP with Australia’s?

• That is, will we measure up to the amount of final goods and services that Australia produces?

• Why/ why not?

• Hence we calculate Real GDP per capita.

Real GDP per Capita

Country Real GDP ($b)

A 100

B 150

By looking solely at this table which country seems better off?

Country B- since real GDP in B is higher than in A.

BUT

What matters is the number of people amongst whom this GDP has to be spread.

Real GDP per Capita

Country Real GDP ($b) Population (million)

Real GDP per person ($)

A 100 5 20,000

B 150 10 15,000

Real GDP tells us the value of goods and services that is produced per person.

The population of A is clearly better off as the real GDP per person is greater in A than in B

Limitations of Real GDP per capita

• Distribution of goods– The calculation of real GDP merely tells us the value of production if we

spread GDP equally across the population. This is almost certainty not the case in real world. We need to know how evenly or unevenly income is distributed across the population

The Lorenz Curve

- Illustrates the distribution of income.

Line of equality. If income was distributed evenly.Line of inequality –

The further the line is bowed out the greater the inequality of income distribution

Limitations of Real GDP per capita

• Rates of unemployment

• The types of goods and services being produced

• The level of the population in the economy

The Production Possibility Frontier:

• The PPF model can be used to illustrate a number of economic concepts, particularly those related to growth.

• Three different ideas of Growth have been outlined already. These were real income, productive capacity, and net social welfare.

• Productive capacity in particular can be shown using the PPF.