What economic growth is
The standard's definition
- The standard defines economic growth as "the issues associated with changes in real GDP, productive capacity, or net social welfare".
- Those are three different things, and the exam tests all three.
| Measure | What it captures | Model that shows it |
|---|---|---|
| Real GDP | How much was actually produced this year | AS/AD and circular flow |
| Productive capacity | How much the economy could produce | PPF |
| Net social welfare | Whether living standards improved | Neither — it is a broader measure |
Gross Domestic Product
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GDP is the total value of all final goods and services produced in a country in a year.
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Break the definition into its four parts, because each carries a mark:
- Total value — measured in dollars, so different goods can be added together.
- Final goods and services — the flour used to make bread is not counted separately, or it would be double-counted.
- Produced in a country — production located in New Zealand, whoever owns the firm.
- In a year — GDP is a flow over a period, not a stock at a moment.
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Economic growth, in its narrowest sense, is the percentage increase in real GDP over a period.
Productive capacity
- Productive capacity is the maximum an economy could produce if all its resources were fully and efficiently used.
- It is determined by the quantity and quality of the factors of production: land, labour, capital and enterprise.
- Capacity and actual output are different. An economy can produce below its capacity — that is what unemployed workers and idle factories mean.
- Capacity grows when the country gets more or better resources: a larger or more skilled workforce, more machinery, better technology, improved infrastructure.
- Capacity falls when resources are destroyed: a disaster that wrecks farmland, roads and bridges reduces what New Zealand could produce, not just what it did produce.
Net social welfare
- Net social welfare is a broad measure of living standards combining economic indicators with quality of life indicators.
- It counts things GDP misses:
- Unpaid and voluntary work — caring for children or relatives, volunteering
- Leisure time and working hours
- Health, education and life expectancy
- Environmental quality — as a negative when growth damages it
- The distribution of income — whether the gains are widely shared
- GDP can rise while net social welfare falls. That possibility is examined directly.
What causes economic growth
More resources
- A larger workforce, through population growth or immigration
- Investment in new machinery, buildings and infrastructure
- Discovery or development of natural resources
Better resources
- Education and training raising the skills of the workforce
- Technology raising output per worker
- Better infrastructure — roads, ports, broadband — lowering the cost of everything else
More spending on what is produced
- Growth also requires demand. Capacity that no one buys from does not become GDP.
- On the AS/AD model this is a rightward shift of AD; on the circular flow it is larger injections.
Worked ExampleWhich measure has changed?
For each situation, state whether real GDP, productive capacity and net social welfare rise, fall, or stay the same. Explain each answer.
(a) A recession causes factories to run at half capacity and 40,000 workers to lose their jobs. (b) A major earthquake destroys roads, bridges and port facilities. (c) A large increase in output is achieved by a new industry that also pollutes a major river.
Step 1 — (a) The recession
Real GDP: falls. Less is actually produced — factories are producing half what they were, and 40,000 fewer people are working.
Productive capacity: unchanged. The factories still exist, the machinery is still installed, and the 40,000 workers still have their skills. Nothing has been destroyed — the resources are simply not being used. On the PPF, this is a move to a point inside the curve, not a shift of the curve.
Net social welfare: falls. Unemployment brings lower incomes, financial stress and worse health outcomes, and the burden falls unevenly across the population.
Step 2 — (b) The earthquake
Real GDP: falls, at least initially, because damaged roads and ports mean goods cannot be moved and production is interrupted.
Productive capacity: falls. This is the crucial difference from (a). Roads, bridges and port facilities are capital — factors of production. Destroying them means New Zealand could not produce as much as before even with everyone working. On the PPF, the whole curve shifts inward.
Net social welfare: falls — lives disrupted, homes damaged, services cut.
Step 3 — (c) The polluting industry
Real GDP: rises. The new industry produces goods that are sold, and their value is counted.
Productive capacity: rises in the short run, because a new industry adds productive resources — but potentially falls in the long run if the polluted river can no longer support farming, fishing or tourism. Environmental capital is a factor of production too.
Net social welfare: ambiguous, and possibly falls. Incomes and employment rise, which raises welfare. But river pollution reduces environmental quality, damages health, and removes recreational and cultural value — none of which is deducted from GDP.
Whether net social welfare rises depends on whether the value of the extra output exceeds the value of what was lost — and GDP does not even attempt to answer that question.