Economic growth: actual vs potential

 Economic growth: increase in national income / output / real GDP

o Produce more goods and services
o Factors of production earn higher income
o Measurement of wellbeing / standard of living
 Actual vs potential economic growth:
o Actual growth: change in national income / output / real GDP
o Potential growth: change in the maximum capacity in the economy when all
factors of production is efficiently allocated
 PPF for actual vs potential growth
o All points on the PPF curve = all resources are fully and efficiently allocated
o Movement from a point within the PPF to the point on the PPF = actual economy
growth.
o Movement from a point on the PPF to a point outside the PPF = potential
economic growth.
 But how to achieve this:
i. Increase in quantity of resources
ii. Improvement in the quality of resources
iii. Improvement in technological level
 How to know what is the level of potential GDP in an economy?
 Aggregate production function
 Potential GDP = aggregate production when all labours are working
 Labour market
 Potential GDP = long run equilibrium in labour market
 Does increase in the quantity of labours / total hours of labours = equal increase in
potential growth?
 No. Why?
 Law of diminishing return
 Increase in quantity of labours / total hours of labours > increase in
potential GDP
 How do you show increase in potential GDP using diagrams?
 Increase in quality of resources (productivity of labour)
 Increase in aggregate production → Production function (PF) curve shifts
upward
 Increase in labour demand → labour demand (LD) curve shifts rightward
 Increase in quantity of resources (total labour hours increase)
 Increase in quantity of aggregate production → upward movement along
the Production function (PF) curve
 Increase in labour supply → labour demand (LS) curve shifts rightward