Economic growth is the sustained expansion of production possibilities measured as the increase in real GDP over a given period. The economic growth rate is the annual percentage change of real GDP. It tells us how rapidly the total economy is expanding.
The standard of living depends on real GDP per person. Real GDP per person is real GDP divided by the population. It grows only if real GDP grows faster than the population grows.
The Production Function and Potential GDP
The quantity of real GDP supplied, Y, depends on the quantity of labor, L, the quantity of capital, K, and the state of technology, A (total factor productivity).
This equation shows that output depends on inputs and the level of technology.
The law of diminishing returns: As the quantity of one input increases with the quantities of all other inputs remaining the same, output increases but by ever smaller increments. As capital per hour of labor rises, output rises (the marginal product of capital is positive) but output rises less at high levels of capital than at low levels. This is the key explanation of why the economy reaches a steady state rather than growing endlessly.
Convergence is the process of one economy catching up with another economy. According to the neoclassical growth theory, countries with a low level of capital would have a higher marginal product of capital because of diminishing returns and hence attract more investment and grow faster.
Growth in Y = Growth in technology + WL (growth in labor) + WC (growth in capital)
where WL and WC = 1 - WL are the shares of labor and capital in GDP.
Sources of Economic Growth
There are five important sources of growth for an economy:
Measures of Sustainable Growth
Labor productivity is the quantity of real GDP produced by an hour of labor. The growth of labor productivity depends on physical capital growth, human capital growth, and technology advances.
Potential growth rate = Long-term growth rate of labor force + Long-term labor productivity growth rate
| schweitzdm: I would highly value a more detailed explanation of the final statement in the "convergence section"|
"Where (WL and WC = 1 - WL) are the shares of labor and capital in GDP"
|schweitzdm: Nevermind, after doing basic question #6 I understand that part|
|choas69: good job!|