2.5.1 Causes of Growth

• Economic growth can occur in the short-run or long-run and each is explained differently

Short-run Economic Growth

• Changes to any of the components of aggregate demand (AD) will cause short-run economic growth to occur
  • This is illustrated on an AD/AS diagram by a rightward shift in AD
  • It can also be illustrated by using the production possibilities frontier model by moving from a point inside the curve to a point closer to the curve
    
    

1. Short-run Economic Growth on AD/AS Diagram

A diagram illustrating short-run economic growth through a shift of aggregate demand from AD→AD₁

Diagram Analysis

• An increase in consumption, investment, government spending or net exports has caused a shift in AD from AD→AD₁
• The current real output has increased from Y₁→Y₂ which represents an increase in real GDP
  • An increase in real GDP = economic growth
• This short-run growth has led to an increase in average prices from AP₁→AP₂
  
  

2. Short-run Economic Growth on Production Possibilities Frontier (PPF)

A diagram illustrating short-run economic growth on a production possibilities frontier (PPF) model

Diagram Analysis

• An increase in production has caused a shift in production combinations from X→Y
• The current real output has increased moving closer to the maximum possible output of the economy
  •  This represents an increase in real GDP
  • An increase in real GDP = economic growth
    

Long-run Economic Growth

• Long-run economic growth is caused by any improvements to the quality or quantity of the factors of production
  • These factors include all of the determinants of long-run aggregate supply

A diagram illustrating long-run economic growth through an increase in the long-run aggregate supply (LRAS) of the economy 

Diagram Analysis

• A change to the quantity/quality of the factors of production has increased potential output of the economy from Y_FE→Y_FE1
  • E.g. More rigorous competition policy creates a higher number of firms in each industry leading to greater aggregate supply in the economy
    • This shifts the long-run aggregate supply curve to the right LRAS₁→LRAS₂ resulting in economic growth
      
• The final impact on price levels depends on the shape of the long-run aggregate supply curve (Keynesian or Classical)

• Actual economic growth occurs when there is an increase in the quantity of goods/services produced in an economy in a given period of time
  • This is often measured by the percentage change in real gross domestic product (GDP)
• Potential growth is the increase in the productive potential of an economy as demonstrated by a shift outward of the production possibilities frontier (PPF) or the long-run aggregate supply (LRAS) curve
• At any given point in time, the actual economic growth may be less than the potential growth available to the economy

• International trade is an important source of income for many countries
• Export-led economic growth refers to growth that occurs as a result of an increase in the sale of goods/services to foreign countries
  • Net exports is a component of aggregate demand (AD)
  • For many developing countries, the exports represent a high percentage of the annual AD and gross domestic product (GDP)
    • When the value of the exports rise, the real GDP rises significantly - and vice versa
• E.g. China experienced significant export-led economic growth from 1988 to the global financial crisis of 2008