14 ECONOMIC GROWTH

Economic growth is measured by two complementary indicators, First, it involves

the rate of change of real output. Real GNP is defined as,
GNP, =the GNP in market prices/(1+ rate of change in prices).
Thereby, the real rate of growth of GNP r , gr is given by gr=g-po. where, g denotes
the rate of change of GNP at market prices p denotes the rate of change of price
level
The second factor Influencing economic growth is the rate growth of output as
determined by technological change. This involves use of factors of labor, capital.
land, energy) in ways that can maximize Reviews their contributions to production
(e.g. production. Hence, payments are made to such factors in accordance with
Reviews their individual marginal products, the means for improving factor
productivity are human resource development, technical change, land
improvements etc.
In perfect competition economy wide, productivity factor will yield efficient
simultaneously aggregate production. But in case of imperfect competition
economy wide, improving factor productivity does not necessarily imply efficient
production economy if the product remains imperfectly competitive .
Thus, while speaking growth economic of principal there are some sources of
economic growth to Consider The two most important sources of labor and Capital
are used in an economically efficient production. It is through quality improvements
o Reviews These factors becomes that economic growth possible.
The factor contributing to the improvement of quality of human labor capital
formation. This is evident in the fact that with the passage of time, the total labor
supply Although Grew remarkably, particularly. due to the influx of women in the
labor force during the post-war times, the total amount of work-time Decreased This
happened Because an industrial society has a propensity to re, particularly. a given
high level of per capita income has been attained, Grew Total economic output by
about five times the growth of the working time c Reviews These trends clearly
indicate the rising productivity of the labor force, the which could only have taken
place through accelerated human capital formation.
The accumulation of human capital in the labor force IS ALSO evident from he shifts
in the labor force from low wage occupations (originally agriculture) to high service),
with the passage of time, a sharper trend (manufacturing, wage occupations in the
labor force toward service sector occupations would again mean slower growth in
GNP per worker, as the service sector is known to be associated with lower With a
shift in labor force from the lower to the higher-paying productivity. occupations,
there is a stabilization of wages in the resulting both occupations in the resulting

from a scarcity of labor, lower paid occupations, and the resulting excess of labor in
higher paid occupations.

The third Influencing Economic growth is capital formation, which means the mobilization of
savings into productive investments. In this way, investment spending along with its positive
effed spending in GNP. economic generates growth. Capital formation used in production linked
with change, thereby determines the mix of technological change. It there by determines the mix
of productive factors to be used in production
The fourth cause of economic growth is structural change. This involves the structure of
production by sectors and the study of interlinkages among Reviews These sectors toward
realizing higher national incomes. The problem of structural change is best studied by means of e
input-output analysis Along with Intersectoral linkages and shifts, the study of structural change
is done in the light of technological change the resulting from an Appropriate mix of factors of
production in the sectoral production menus.
VARIOUS FORMS TECHNOLOGICAL CHANGE
Capital widening and Capital Deepening Technical change
Labour cannot improve in quality all by itself II requires the support of capital. Capital
contributes to the quality improvement of Labour through capital widening. This means the rate
of change of het capital expenditure changes at a rate that is comparable labor, capital structure
Also through capital deepening contributes. This means that each unit of labor comes to acquire
increasingly more use its endowment capital.
A higher level of capital formation through savings comes about, through savings, which in turn
is used as a resource to produce capital goods. Thereby, as society goes on to optimally, less
toward consumption and more toward investment allocate its resources e process of investment
is expected to yield higher economic growth.
Labour-Augmenting Technical Change The right proportion of using capital and labor in
production Gives rise to special forms of production menus towards generating higher levels of
output than could be Alternatively possible. This is a notion of technological change attained by
means of Various types of technological such change can be Appropriate factor combinations.
identified
First, we Consider the type of technical change. It labour augmenting type of technical change. It
occurs when the quality of labor measured in terms of number of persons decreases over time
with a given input of capital, but labor input in terms of efficiency units (i.e. human capital
formation) does times more of the work that it was doing before
Aggregate Production Function technical change
To understand such a labor-augmenting technical change, we first explain the idea of the
aggregate production function. is an economy-wide menu of efficient production

Of goods and services by means of aggregate capital and labor or the aggregate
level output gives the optimal level of production. Corresponding to it labor and
capital are assumed to be fully employed. The aggregate production function is
given by. Q-FKL) denotes aggregate output wide economy.
where.

Q denotes aggregates output economy wide

L denotes aggregate wide supply of labor economy wide stock:

K denotes the aggregate supply of capital as an economy wide
F (KL) denotes the menu of using capital and labor in a given mode of
production endowed by a
technology turn out the potential level of output Q
Labour augmenting technical change implies that with L replaced by L=.L Labouraugmenting over time, the potential output level is thought to be maximized by the
most productive use of KL^). Now. Q =(FK LT.)
Marginal substitution between K and L^ would show that the aggregate production
frontier shifts with technical change in favor of the goods using isoquants possibility
of labor in efficiency units will more intensively than capital. The production
isoquant will consequently shift in favor of such labor in efficiency units. In figure
14 we show corresponding to shifts in the production possibility the nature of
shifting isoquant quantities of the labor-intensive good shift from QL to Q with
technological curve. change (A goes to B on the production possibility curves). while
the capital-intensive Consequently, the iso good cost remains unchanged during the
technological change. line shifts in favor of labor with a relatively lower price-tocapital. Point A 'an the isoquant I, shifts to B on I 2
Figure 14.1: Labour-Augmenting Technological Change

Capital-Augmenting Technical Change

By symmetrical discussion as above, technical change in the aggregate production function
would mean maximizing Q by means of the most efficient use or KL) over time. Now.
Q= F(K^,L) , with K^=.K, being the capital augmenting constant.
The production curve will possibility Shift in favor of the good using K^ intensively than L more
than L. The isoquants will shifts in favor of capital These are shown in Figure 14.2. The
explanation given here Similar that in figure 14.1.
Figure 14.2:Capital-Augmenting Technological Change

Change Capital and Labour- Augmenting Technical Change

By Similar explanation as above, it is straightforward to understand the meaning of production
and shifts with menus factor induced by technical change both on the side between Reviews
These factors in of capital and labor , There is an inherent complementarity ily join such a
technical change menu.
In general we now have,
Q=F(K^,L^), with l=.L,K^=.K,.
When >. shifts of the production frontier possibility isoquants and production are
relatively more in favor of labor and the labor intensive good when. > , the converse is true.
In the case of capital and labor equally augmenting. that is, neutra1 type of change, the
shifts remain parallel to each with shins in the technological quants and production possibility
frontiers Now a Production
The case of technical change is shown in figure capital-labor-augmenting 14.3.
Whichever is the cage of technical change, it is important to note that such
technical change menus are adopted menus are not because of relative availability.
Rather it is the technically-induced factor that is being abundantly used, irrespective
of the relative abundance or scarcity of that factor in the production aggregate
menu however, an abundant factor is being technically induced, then there is both
an economic as well as a social gain from the technical augmentation of tut factor
The construction of the production and isoquants shown in figure 143 is similar to
the previous two cases.
Figure 143: Equally Labor-capital Augmenting Technological Change

EXPLAINING GNP BY MEANS OF

THE AGGREGATE PRODUCTION FUNCTION
How GNP is generated by means of the aggregate production function? The starting
point for the generation of GNP is production of economic output, the which we
have termed Earlier is value added. By aggregating the value added by sectors we
Obtain national income. Value added is also the value of final demand by sectors.
Production of value added requires factor inputs, such as, capital and labor.
Production cost factor measures the total cost. We now have the problem of output
classical economic maximization, subject to cost constraints:
Max.Q=F(L,K)
subject to, C = w.L+r.K
where, C denotes the cost of production: w denotes wage rate; r denotes rental on
capital or cost of capital r can be taken as the interest rate or as the opportunity
cost of capital. L denotes total labor supply in the economy hired by firms and
supplied by household conditions. L is not an aggregation of labour employed by
each and every demographic firm on the basis of lateral aggregation across the
economy. The measure of L is the sampling and estimation. The reason for treating
L and K Obtained by macroeconomic likewise in full employment in the aggregate
production function is for o to represent optimal output (potential output) K denotes
the total capital stock in the economy given as the cumulative value of old and new
investments, replacement

demand , government expenditure on investment net private capital expenditure, all o the which
together yield aggregate capital formation.
Since all of the production costs Becomes payments in factors of production as wages
(w) or Profit/returns/interest (r), therefore, C must be a measure of value added. In other words,
this total payment as u production cost is received by household and is subsequently spent to buy
back all the output in the economy. The well-known knowledge of economic equilibrium in the
general top of goods and services is invoked. It is also equivalent in the fact that Q is bought by
c. Hence in value terms , C=Q

In the microeconomic profit maximization case, the equality, C=Q, means that Product
exhaustion Occurs and revenue equals cost, Q being then Expressed in terms of dollar value.
Now when such a Q value added is aggregated over all producers in the economy. we obtain the
estimate as national income
If we furthermore add Depreciation demand such as payments to capital, and the equation
takes the form taxes on goods and services, the cost of aggregate production takes equation takes
the form,
C= NI + r.K+r.Q
This must equal by the same general equilibrium requirements of the circular top o goods
and services in the economy ere denotes taxes on incomes, goods and o, al the rate per unit of Q.
In this form, the C denotes total expenditure, which from the side of incomes now equals F+ T
+D.F denotes factor incomes: T denotes indirect taxes. D denotes de demand in investment as.
Hence, Q attained by this total income method is the gross national product, GNP Thus the
production function approach yields the same national output and its composition as we found in
the case of the national income accounting and the input-output relationships.
Sales taxes are paid to government programs by buyers at large. These in turn enter the
production of goods and services in the form of prices. The cost of In These productions are once
again transformed to factor incomes that enable the buying back of GNP. Thus, all sales tax
payments result in the transfer of purchasing power from the private to the public sector
thereafter, they generate demand in the marketplace Sales taxes as costs to the company are not
shown in the production cost, Because they of deductions. But since all tax-payers are household
members, and are of the nature is reflected in payments to factors, therefore, sales taxes emanate
Ultimately e household level.
Depreciation costs on capital equipments are recouped by businesses adding them to the
price of the product. This component or hence of the product generates a revenue of the firm But
a port of revenue spent in replacement demand on capital together with after-tax yields compose
the Thus replacement Capitalization of the value of the company now Suggests that cash-flows.
company's as long as there are steady cash-flow, CF, to business. the replacement cost, will be
capitalized by the present-value of the stream of cash-flows in perpetuity. We can now write the
capitalization formula as follows, with i as the interest rate of denoting cost of capital
D= CF/i

ROLE OF OTHER TAXES: ALLOCATIVE AND DISTRIBUTIVE ASPECTS

Personal Aspects taxes serve an allocative and distributive function in the economy
by becoming sources of transfer between the government that collects and
distributes taxes; and Households and businesses that receive transfer payments
and such taxes respectively. Hence, when we are considering personal and
corporate taxes menus, in the national income accounting equation. They appear as
news from government sources either to Households or to businesses

Besides the distributional function of taxes, taxes also act as allocative

resources and linking production investment activities The link between
consumption. allocative and distributive aspects of taxation can be seen in the
representation of taxes in terms of the circular flows of goods and services in figure
14.4.We show that all taxes ultimately emanate from household level .Tax flows
occur at points denoted by 1( =personal income taxes); 2 (=consumption direct
taxes as indirect taxes) .3(=firms pay taxes on and services tax). 4(= firms pay
taxes on manufactures, receipts), 5(= taxes on factors e.g. payments), 6(= payroll
paid by firms). 7 (=taxes on profits of firms) 8(=Taxes on wages paid by
employees): 9 (=taxes paid on demand by firms). 10(=taxes on dividends cashed)
The figure also shows how household income is distributed between
consumption and savings .The consumption expenditure then into the Consumer
Goods markets, which then become receipt by firms .Household savings enter the
capital market and investment expenditure. These enable firms to manufacture
capital goods, which too become sales and receipts to firms. From receipts factor
payments are made. These are subsequently taxed as shown
Figure 14:41 Collection and Distribution of Taxes in the Economy

POSTSCRIPT TO THIS CHAPTER

It is quite clear that economic growth in economic theory is a premium on

neoclassical formulation of aggregate function. In this all the implications production
of marginal substitution Appear on the side of both output and factors. Subsequent
to these conditions assumed to exist for the Attainment of optimal production and
efficient use of factors, technological change too is seen to fit these conditions.
Hence, Although Production possibility curves and isoquants shift in specific ways
corresponding to the kinds of technological change induced in them, the structure
of productive and allocative relations n output and factors remains the same. The
optimal production points, and thereby, the points of efficient allocation of factors,
are long-run and steady-state points Whether or not they are induced by
technological change
In the process oriented political social economy explained earlier that we
have technology as a Learning medium of the interactive system is endogenous.
Along with this, the causal polity-market interrelationships at the decision-making
points generate evolutionary points that cannot be represented on concave to the
origin of production possibility curve. Consequently, the convex form of the
production isoquants cannot exist.. Pricing and allocation in the substantively
distributional sense, and too in simultaneity with economic efficiency, take place
along the knowledge-induced evolutionary trajectory, output expansion but is made
up of which appears as evolutionary points and not the gyro-run, steady-state
points of neoclassical optimum
The production and distributional menus are derived The production relations
of the underlying distributional and social well-being function of Islamic political
economy. Hence, any point evolving social well-being surface has a corresponding
on the knowledge-induced point on the production menu, and thereby. on the
allocation factor trajectory. We now write Lie simulation system
Simulate {} SW= SW(Q(), L(),K(), )
Subject to

Q()=f1 (L(), K(), )

L

denotes iterative values of the ordinal variables knowledge

The QUESTIONS Take the Intal cost of prod uction for a company X to be s100
milhon: with taxes amounting to 10% of this ourput. Now set up a cast simmary for
the firm by realistie figures, Compuie the factors on costs, material costs and
depreciation. what is the patential buy-back value added for this company if the
output is capitalized in perpetuity? since capitalization in perpetuity is just another
way of intertemporal discounting of cash-flows, and can not be an accepted valua:

methodolopy ions in th knowledge-induced political social economy. generate some

realistic causal