Economic Growth

Measures of Economic Growth

Economic growth is defined as the percentage
change in an economys GDP or GNP values.
It is an indicator of an economys progress
A closely related concept is the growth rate of
output per person, indicative of an economys
standard of living

Quarterly GDP Growth Rate, June 2014

10

-2

Iran
Brazil
Greece
Norway
Italy
Finland
Argentina
Japan
France
Denmark
Thailand
Switzerland
Austria
Euro
Germany
Area
Russia
Portugal
Belgium
South
Venezuela
Netherlands
Africa
Spain
Mexico
HongChile
Kong
Turkey
Singapore
Israel
Czech
Canada
United
Sweden
Republic
United
Australia
States
Poland
Kingdom
South
Egypt
Pakistan
Saudi
Korea
Taiwan
United
Colombia
Arabia
Iraq
Indonesia
Arab
India
Malaysia
Philippines
Emirates
Nigeria
China
Ireland

Ratio of GNI per Capita to GNI, 2013

250

200

150

100

50

0
China
United
India
Indonesia
Pakistan
States
Nigeria
Russia
Japan
Mexico
Philippines
Egypt
Germany
Turkey
Thailand
France
Australia
South
Italy
Colombia
Africa
Spain
Poland
Canada
Venezuela
Iraq
Malaysia
Saudi
UnitedArabia
Netherlands
Kingdom
Chile
Belgium
Czech
Greece
United
Portugal
Republic
Sweden
Arab
Austria
Switzerland
Israel
Emirates
Hong
Denmark
Kong
Finland
Singapore
Norway
Ireland

Factors Affecting Growth Rates

Physical factors
Climate
Natural resources
Location
Natural hazards

Political factors
Trade
Corruption / poor management
War

Social factors
Discrimination
Population

Production Possibility Frontier (PPF)

The PPF shows the maximum quantity of
goods that can be produced efficiently by an
economy given its technological knowledge
and the quantity of available inputs.

PPF & Economic Growth

Economic growth occurs when a countrys PPF
shifts outward.
Public vs. private goods
Luxury vs. necessary goods
Consumption vs. investment goods

Productivity
Productivity is defined as the ratio of output to
a weighted average of inputs
Four determinants of productivity
Human resources (L)
Capital resources (K)
Natural Resources or Land (R)
Technological change and innovation (T)

Aggregate Production Function (APF)

Q = f (K, L, R, T)
Alternatively, Q = f (K, L) where R forms a part of
K and T is assumed to be fixed.
L grows at a given or constant rate
Capital deepening, an important driver of growth, is
defined as the capital-labour ratio or quantity of
capital per worker

APF

As capital deepening takes place for a given

technology, the increase in output-labour ratio
becomes smaller because of diminishing returns to
capital

APF & Technological Change

In the long run without a technological change, the
capital-labour ratio will stop rising, the economy will
enter a steady state in which capital deepening ceases,
real wages stop growing, returns to capital are constant.
If economic growth consists of only accumulating
capital with existing methods of production, without any
technological change, then economic growth will
stagnate and the standard of living will stop rising.
APF shifts when new technology is augmented & the
growth process is reinvigorated.

Cobb-Douglas Production Function

Qt = Tt Kt Lt

gQ = gT + gK + gL
g denotes growth rates
is the partial elasticity of output with respect to capital
is partial elasticity of output with respect to labour
+ > 1 increasing returns to scale
+ = 1 constant returns to scale for, and
+ < 1 decreasing returns to scale for

Total Factor Productivity (TFP)

TFP is defined as the change in output caused by
change in technological innovation
It is the portion of output not explained by the
amount of inputs used in production
It is measured using Solow residuals under the
assumptions:
production function is neoclassical
there is perfect competition in factor markets
the growth rates of the inputs are measured accurately

Solow Residual
A constrained Cobb-Douglas Production
Function has + = 1 or = 1
Solow residual is defined as
gT = gQ gK (1 ) gL

Indian Scenario

Reasons for Decline in TFP

Administrative and bureaucratic tangles

Poor infrastructure
Barriers to investment
Unskilled labour force
Lack of innovation
Persistent inflation
Current account deficit, and
Slow growth in private investment

Savings and Investment Rates

45
40
35
30
25
20
15
10
5
0
Total Investment/GDP

Gross National Savings/GDP

Annual Growth Rate of TFP by Broad Sector,

1980 2008
Broad Sectors

Total Factor Productivity

Agriculture, Hunting, Forestry,

Fishing

1.68

Mining & Quarrying

-0.17

Manufacturing

1.30

Electricity, Gas & Water Supply

2.62

Construction

-3.31

Services

2.07

Total Economy

1.74