Economic Growth in the Short-run and Long-run

in this lesson we're going to focus on economic growth now you've been studying economics for some time at this point and you've surely come across the definition of economic growth in previous lessons economic growth is simply defined as an increase in a nation's output of goods and services over a period of time another way to look at economic growth is that incomes are increasing on average in the nation over time so you could say it's an increase in average incomes over time in previous lessons we've distinguished between the income and the output approach to measuring GDP so therefore there's actually no difference when you're referring to GDP growth as an increase in output or an increase in income and this lesson will distinguish between short run economic growth sometimes called actual growth and long run economic growth sometimes referred to as potential growth and we'll be doing this in two different models both the production possibilities curve which is the very first graph you ever learned in your economics class and in the ad AS model which is a macro specific model that you have learned more recently let's start with actual or short-run economic growth actual growth short-run growth occurs when there is an increase in the equilibrium output of a nation that is producing below its full employment level another way of looking at that is inside its PPC so graphically what does actual or short-run growth look like let's add some labels to our graphs and will illustrate short-run economic growth using both the PPC and the a das model from my production possibilities curve I'm going to look at the vertical and horizontal axes as the production of as the production possibilities of two different categories of goods both consumer goods on the vertical axis and capital goods which are those technology tools used by firms to produce other goods on the horizontal axis we know that due to the scarcity of natural and human and capital resources there is a trade-off as a country faces its decision about what combination of capital and consumer goods to produce therefore there is a production possibilities curve that shows the potential output of a nation if it uses all of its resources efficiently so when a country is producing at a point inside and call this point a its production possibilities curve this implies that it is not using all of its resources efficiently there is excess capital labor and land resources that are not being used efficiently unemployment is high the country is producing inside its PPC and we assume it is below its potential full employment level so a movement from point A to a quote to a point closer to the PPC I'll label this point B represents economic growth as you can see there is an increase in the output of both capital goods as we move along our horizontal axis and consumer goods as you move along our vertical axis this movement from point A to B represents actual economic growth output is increased in the short run to a point closer to the nation's production possibilities curve however as we're going to see in a moment this is not an increase in the potential growth of the economy whereas the country is using its resources more efficiently it is not increasing the quantity of the quality of the resources available for production let's show how actual economic growth or short-run growth can be illustrated in the a das model now in our aggregate demand aggregate supply model we know that the potential output of a nation in the short-run is represented by the vertical lris curve which is above the full employment level of output we know the horizontal axis shows real GDP and the vertical axis shows average price level we know there's a short-run aggregate supply curve showing how the economy will determine its equilibrium output based on the level of aggregate demand and aggregate supply at any particular time now an economy that is achieving actual growth or short-run growth is an economy that is seen aggregate demand increase for example from d12 a level of demand closer to the full employment level which I'll call ad to notice in this model there is an increase in the actual level of output from y1 to a point closer to full employment we'll call that y2 so we have an increase in real GDP this is economic growth along with that growth comes a little but not a lot of demand pull inflation the reason there's not much inflation of course is that there are many unused resources in the economy when the economy is producing below full employment labour land and capital are relatively abundant therefore firms can meet the higher level of demand without raising their prices and without having to pay more for their resources so we see an increase in actual output this represents actual or in our a das case short-run growth as the economy is moved from a point producing below full employment to a level of output closer to the full employment level so going back to our notes here we can describe the change in actual output as a movement from a point inside a nation's PPC to a point closer to or on the PPC resources are used more efficiently there is a reduction in unemployment capital that might have been sitting idle has been put towards production once again actual output increases in an ad AS model this is illustrated as a movement in equilibrium now let me change that an increase in equilibrium output from a point below full employment to a point to a level closer to full employment the sources of short-run actual growth are rooted in increased efficiency in the use of resources so resources are used more efficiently unemployment Falls idle capital and land are put into production notice that what has not changed in the case of short-run economic growth is the potential output of the nation there has been no increase in the quantity or the quality of resources only the efficiency with which existing resources are used or the level of employment of existing resources in both cases in both the PPC and the ADIS model output has increased but there has been no increase in potential output and economy has just gone from producing at an inefficient level which would be y1 in my adias graph or point a in my PPC graph towards a more efficient level which would be y2 in my a das graph or point B in my PPC so let's distinguish now between short-run economic growth and what we call potential growth or long run economic growth potential growth is achieved when there is an increase in the production possibilities of a nation or the long-run potential level of output graphically we're going to see this is illustrated as an increase in the PPC or an increase in long-run aggregate supply let's start with our PPC here a country moving from point A to point B is growing its output is increased it has moved closer to its production possibilities however in order for long-run potential growth to occur the country has to move to a point beyond its current PPC talk about now Point C which as you can see is currently impossible because it's beyond the PPC but in order to make Point C possible the PPC has to shift out this shift out of the PPC represents potential growth growth in the potential output of a nation which is achievable in the long run as a result of several factors which will outline in just a moment so an increase in the production possibilities means that the potential level of output a country can achieve the combination of both capital goods and consumer goods it produce increases due to an increase in the productive capacity of the economy so moving from point B to C we witness an increase in both consumer goods and capital goods to a level beyond what was previously possible and that brings us down to our a das model I think you won't be surprised to see that long-run potential economic growth is illustrated as an outward shift in the long-run aggregate supply curve from L ras to l RS to this outward shift represents an increase in the full employment level of output along with L Ras we're going to see short-run aggregate supply curve shift out to s ras – and in fact aggregate demand will shift out as well – ad 3 now if we can make sense of all the lines in this graph we can see that the new equilibrium level of output the new full employment level of output is at a higher point than it was before the outward shifts in ad and a s graphically potential economic growth otherwise known as long-run economic growth is represented by an outward shift of a nation's PPC and a level of output beyond what would have been possible before the long run economic growth occurred or an outward shift of the long-run aggregate supply curve s ras and aggregate demand long-run economic growth generally is illustrated as an hour shift of all three curves as an outward shift of all three curves there is a greater potential level of output which is now demanded at a greater level as well what are the sources of long-run economic growth what can cause the potential output of a nation to increase over time that's what we're really talking about here the sources of long and economic growth are slightly different than those from short-run growth because it requires an increase in the quality or the quantity of productive resources factors of production by which you mean land labor and capital so perhaps this requires a little bit more explanation how do you increase the quantity of land labor and capital well there are several ways land let's start with land discovery new resources or finding ways to use existing resources more efficiently technology can increase the productivity and the quality of the nation's land resources for example farming technologies or mining technologies chemical fertilizers new methods for extracting resources such as hydraulic fracturing which is being used widely in the United States to increase the quantity of natural gas and other energy resources pesticides increase the quality of land for farming these are ways that a nation's PPC or El Ras can shift out by focusing on the improvement in the quantity or quality of land resources what about capital resources capital resources the factors of production that require technology or robotics or any machinery that's used in the production of a good will be improved in the quality and quantity by investment so investment by firms in new technologies or better technologies increases both the quantity and the quality of capital and leads to long-run economic growth finally labor how do you increase the quantity of labor well population growth higher birth rates will in the very long run increased the productive capacity of the economy more labor entering the labor force more people entering the labor force increases the potential output and the aggregate demand in the nation hence shifting both LRA s and s Ras outwards and aggregate demand for that matter in addition to population growth you could have emigration more emigration increases the potential output of a nation causing long-run economic growth now both population growth and immigration refer to the quantity of labor what about the quality of labor better education systems or job training programs can increase the quality of labor hence increase pro activity now this word productivity is very important when discussing economic growth both in the short run and in the long run productivity refers to the output per unit of inputs land becomes more productive when technology is used in the production of mineral or agricultural resources labour becomes more productive when technology is added when capital is provided to workers they become more productive or when education is provided to workers capital itself becomes more productive when investments and new technologies are undertaken by firms so productivity is improved through investment in physical land and labour resources so capital land and labor can all be improved now this investment this could uh could be undertaken by the private sector meaning businesses or the public sector some types of investment are best undertaken by the public sector investments in education for example investments in health care these are investments that can increase the quality of labour resources and therefore lead to long-run economic growth in the nation in this lesson we have defined economic growth which is a concept in a term that you were no doubt familiar with before watching this lesson but we've also gone into some of the graphical analysis of and the sources of both short-run and long-run economic growth we showed that an increase in actual output or short-run growth occurs when a country moves from a point inside its PPC to a point closer to its PPC or when aggregate demand increases from a point below full employment to a point closer to full employment long-run economic growth on the other hand entails an increase in the productive capacity the potential output of a nation and the full employment level of output achievable through an improvement in the quantity or the quality of land labor and capital resources one step back

  1. how about when the economy is in an inflationary gap and y1 > yfe? How do you illustrate that point on a ppc?

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