What Is Economic Growth?
Economic growth is an increase in the production of economic goods and services in one period compared with a previous period. It can be measured in nominal or real terms. Traditionally, aggregate economic growth is measured by Gross National Product (GNP) or Gross Domestic Product (GDP), though alternative metrics are sometimes used.
Key Takeaways
- Economic growth is an increase in the production of goods and services in an economy.
- Increases in capital goods, labor force, technology, and human capital can all contribute to economic growth.
- Tax cuts are generally less effective in spurring economic growth than are increases in government spending.
- Economic growth is commonly measured in terms of the increase in aggregated market value of goods and services produced, using estimates such as GDP.
Understanding Economic Growth
In simple terms, economic growth refers to an increase in aggregate production in an economy, which generally manifests as a rise in national income. Often, aggregate gains in production correlate with increased average marginal productivity. This leads to an increase in incomes, encouraging consumers to spend more, thus enhancing the material quality of life and standard of living.
Economists model growth as a function of physical capital, human capital, labor force, and technology. Increasing the quantity or quality of the working-age population, the tools they use, and the methods they combine labor, capital, and raw materials will boost economic output.
Phases of Economic Growth
The economy moves through different periods of activity known as the business cycle. It consists of four phases:
- Expansion: During this phase, employment, income, industrial production, and sales all increase, with a rising real GDP.
- Peak: This is the point at which an economic expansion hits its maximum extent, acting as a turning point.
- Contraction: Here, the elements of expansion begin to decrease. A significant decline in economic activity may result in a recession.
- Trough: This phase marks the lowest point of economic contraction.
Business cycles vary in length and can involve periods of contraction during expansion and vice versa.
How to Measure Economic Growth
The most common measure of economic growth is real GDP, adjusting for inflation. There are three methods for examining real GDP:
- Quarterly growth at an annual rate: Measures GDP changes from quarter to quarter, compounded into an annual rate.
- Four-quarter or year-over-year growth rate: Compares single quarters of GDP from successive years as a percentage.
- Annual average growth rate: Averages the quarterly rates to find the annual growth rate.
GDP is calculated by summing all money spent by consumers, businesses, and the government. The formula is:
GDP = consumer spending + business investment + government spending + net exports
Measuring commodity value can be complex as different goods hold varying importance for individuals.
How To Generate Economic Growth
Economic growth depends on four key areas:
Increase in Physical Capital Goods
Adding capital to the economy enhances labor productivity. Newer and better tools allow for increased output but require initial savings and proper deployment of those resources.
Improvements in Technology
Technological advancements enable workers to produce more output with the same stock of capital goods. Innovations like gasoline fuel can drastically heighten productivity.
Growth of the Labor Force
More workers typically result in more economic output. However, they must be productive enough to support their subsistence and ideally complement the capital goods they use.
Increase in Human Capital
Increasing human capital means elevating workers’ skills through training, experience, or education, which boosts productivity. Social and institutional capital, including political and economic innovations, also contribute to raising productivity.
Why Does Economic Growth Matter?
Economic growth means more resources for more people and is a key focus for governments striving for development. It influences not just economic wealth but also societal progress. Research indicates that countries which reduce poverty and increase access to public goods leverage strong economic growth; however, unequal distribution can undermine sustained growth.
How Do Taxes Affect Economic Growth?
Taxes impact economic growth by influencing demand. Tax cuts can raise personal disposable income and encourage business investments. The Economic strength significantly determines the impact. Effective growth stimulation often comes from targeted tax cuts to lower- and middle-income households, who are less likely to save additional income.
Alternative Terms for Economic Growth
Alternative terms for economic growth include ‘boom’, ‘prosperity’, ’economic development’, ’economic upswing’, ’economic upsurge’, ‘industrial development’, and ‘buoyancy of the economy’.
The Bottom Line
Economic growth is an increase in the production of goods and services over a given period, mostly measured as GDP. It indicates overall economic health, and its sustenance depends on equitable distribution of the benefits derived from growth, fostering societal health and progress.
Related Terms: Gross Domestic Product (GDP), Business Cycle, Gross National Product (GNP), Human Capital, Economic Development, Government Spending.
References
- Oxford University Press. “Overview: Economic Growth”.
- Khan Academy. “Lesson Summary: Economic Growth”.
- Congressional Research Service. “Introduction to U.S. Economy: The Business Cycle and Growth”.
- CNBC. “Federal Reserve Approves First Interest Rate Hike in More Than Six Years”.
- Bank of Canada. “Measuring Economic Growth”.
- The World Bank. “Why Can’t I Find Estimates of Gross National Product (GNP)?”
- U.S. Library of Congress. “U.S. History Primary Source Timeline”.
- United Nations University World Institute for Development Economics Research. “Why Should I Care About Economic Growth?”
- Urban Institute & Brookings Institution Tax Policy Center. “How Do Taxes Affect the Economy in the Short Run?”
