What is Economic Growth?
Economic growth is a broad term that describes the process of increasing a country’s real gross domestic product (GDP). The growth can be measured as an expansion of real GDP or gross national product (GNP) over a given period.
With an increase in GDP or otherwise, the value of goods and services produced, people in a country can afford to consume more. To increase goods and services, countries must increase their capacity to produce. Therefore, in a deeper sense, economic growth involves the analysis of variables that lead to sustained expansion of production capacity.
- Economic growth is a broad term that describes the process of increasing a country’s real gross domestic product (GDP).
- Economic growth and the expansion of production capacity result from technological change and capital accumulation.
- The rate of economic growth refers to the percentage change of real GDP from one year to another.
Understanding Economic Growth
Economic growth exerts a direct impact on the quality of the people’s standard of living. As production capacity rises, incomes increase, and consumers can buy more goods and services. With higher incomes and more production, they together work to increase productivity. The cycle continues as productivity in the factors of production rapidly grows real GDP.
Consumers may benefit from more job opportunities, and the government can use tax revenues to spend on public services. They are just a few examples of the significant influence of economic growth on the standard of living.
Sources of Economic Growth
Economic growth and the expansion of production capacity come from technological change and capital accumulation. If a country puts all its resources to produce goods and services and none of its resources to accumulate capital, its production capacity will not change.
There is essentially a tradeoff between more production now or economic growth in the future. For a country to achieve increased future consumption, they must decrease the production of goods and services. The forgone current consumption is the opportunity cost of economic growth.
1. Technological Change
Technological change involves innovating and finding more efficient ways of production. As new technologies are adopted, a company can produce more output at a lower cost. With lower cost techniques, companies are likely to provide either lower prices or a greater quantity.
Next, we discuss capital accumulation. Any advances in technology for a company come with an increase in capital.
2. Capital Accumulation
Capital accumulation refers to the growth of capital resources, such as human capital and physical capital. Human capital is the skill and knowledge held by an individual. It may result from education or work experience. As millions of individuals learn and become more productive, human capital will grow significantly.
Physical capital may include additions in equipment, machines, or buildings. It leads to larger amounts of capital per worker, which results in increased productivity. The accumulation of physical capital is fundamental to economic growth and important in all areas of the economy, from a factory to a shopping mall.
The Economic Growth Rate
The rate of economic growth refers to the percentage change of real GDP from one year to another. To calculate the growth rate, the following formula is used:
Example of Economic Growth
Consider the following as an example of the sources of economic growth. Both Country A and Country B are two different countries. Country A’s production capacity is five times that of Country B. Country A dedicates only one-fourth of its resources to capital accumulation. Meanwhile, Country B dedicates one-third of its resources to capital accumulation.
While both countries are experiencing economic growth, Country B would experience a quicker expansion in production capacity than Country A. Country B experiences faster economic growth than Country A.
If Country B continues to dedicate its resources to capital accumulation, it may be able to catch up to Country A’s level of production capacity over time. Rapid economic growth sustained over a few years can transform a developing country into a developed one.
CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.
In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful: