Economic Growth

Achievement Standard 2.3

4 Credits
 Economic Growth

One of the government’s key objectives is to increase

economic growth.
Economic Growth occurs when the economy produces more
goods and services.
There are three views of what economic growth actually is:

An increase in…

Net Social
Real Welfare
Productive
Income
Capacity
 Growth as Increased Real Income

This measures increases in actual economic output.

To calculate this, we measure the quantities of goods and
services that the economy produces, by calculating the dollar
value of production, called Gross Domestic Product.
GDP is the dollar value of the total production of final
goods and services in an economy in one year.
Therefore if GDP increases, then this indicates that there has
been an increase in the number of goods and services produced
in an economy.
- This measure allows us to compare production and real
incomes between countries.
 Nominal GDP

Nominal Gross Domestic Product is the current

production level valued at current prices.
It is calculated by multiplying the quantity of goods and
services by the price paid for each unit.
GDP = P x Q

Since the value of GDP is partly measured by prices, we

need to be able to distinguish between increases in GDP
which are caused by increasing prices, and an increase
brought about by increases in the quantities of goods and
services produced.
 Real GDP

Real Gross Domestic Product is calculated as the

current year’s production valued at a constant (or base)
year’s prices.

In a real economy of course there is more than one good,

therefore the following approach is used:
Nominal GDP
Real GDP = x Price Index in Base Year
Price Index

Using Real GDP highlights the changes in actual production, or in

economic growth.
 Real GDP

Copy and Complete this Table by Calculating the

Missing Figures:

Calculating Real GDP and Economic Growth

Year Price ($) Quantity Nominal GDP Real GDP Growth Rate (%)
1 4 10 40 40 -
2 5 12 ? ? 20%
3 5 ? 75 ? ?
4 ? 20 120 ? ?
5 6 24 ? ? ?
A Comparison of Annual % Real GDP
 Components of GDP

+ Consumer Spending C
+ Investment by Firms I
+ Government Spending G
+ Change in Stocks (to account for goods produced, but not sold) R
+ Exports X
- Imports M
+Statistical Discrepancy (to balance the expenditure and income
approaches) SD
Calculating GDP Using Expenditure Method

This measure the total amount of purchases on final

goods and services that have been produced, each
year:
Final Consumption Expenditure private or households (C)
+Investment or Gross Fixed capital formation (I)
+Government Spending or Final consumption expenditure
public or Government (G)
+Changes in stocks (values of goods and services stored)
(∆R)
+(Exports (X) - Imports (M))
+Statistical discrepancy

= C + I + G + ∆R + (X-M) +SD
 Statistical Discrepancy

 This is the term given for the different

measurement systems not matching up.

 For example, a person may not declare their

income from a cash job, but it would be
picked up when they spend their money!
Example
(Using NZ System of National Accounts Terms)

Item $m
Final Consumption Expenditure 60
Private (C)
Gross Fixed Capital Formation (I) 7
Final Consumption Expenditure 21
government (G)
Increases in Stocks (Change in R) 1
Net Exports (X-M) 3
GDP 92
Calculating GDP Using Income Method

 This calculates GDP as the sum of all

incomes created in production.
 Calculated as:
Compensation of Employees (wages, salaries)
Gross Operating Surplus (profits) +
Taxes on Production - Subsidies
Example
(Using NZ System of National Accounts Terms)

Item $m
Compensation of Employees 41
(salaries and wages)
Operating Surplus 29
Consumption of Fixed Capital 10
Indirect Taxes 13
Less Subsidies 1
GDP 92
Limitations of GDP Statistics

Non-market activities are not included

For Example:
 Housework and volunteer work is excluded
 If the producer consumes the production there is
no surplus to sell on the market
 Illegal activities are excluded
 Private sales are excluded
 Any barter transactions
 Limitations of GDP Statistics
 Negative vs Positive Production
 There is no indication whether the economic activity
was positive or negative. E.g. did a natural disaster re-
build cause an increase in production?
 There is no indication that quality of life has
improved, longer working hours and less leisure time
will increase GDP, but arguably lower standards of
living
 There is no indication whether national income is spent
on defence or education and health
 Income Distribution
 There is no indication of how national income is
distributed among the population and which regions
are growing by more
 Strengths & Limitations of Using GDP as a
Measure of Growth

Strengths:
- Shows if the whole country is earning more income.
- Shows if more goods and services have actually been produced.
- Shows that more goods and services can be bought.
- Objective and measurable.

Weaknesses:
- Does not show how income is distributed.
- Does not show the composition (make-up) of output.
- Does not take into account the impact on the environment.
- Does not show illegal or ‘under the table’ transactions.
- Does not include wealth.
Growth as Increased Productive Capacity

Increasing the productive capacity of an economy means that

it is able to produce greater quantities of goods and services.
An increase in productive capacity means that there is more
investment in the economy, therefore its stocks of capital
goods have increased – hence, there are more capital goods
available for production.
However, even as new capital goods are added to the economy,
other existing capital goods are either wearing out or
becoming obsolete (i.e. depreciating).

Gross Capital Fixed Formation – Depreciation = Net Fixed Capital Formation

Strengths & Limitations of Productive Capacity
as a Measure of Growth

Strengths:
-Shows if country is able to increase the production of goods
and services.
Weaknesses:
-Does not indicate if more goods and services have actually been
produced.
- Does not indicate if standard of living has improved.
- DIY and craft activities are not included.
- Do not know the purchasing power of the household.
- Does not indicate efficiency.
Growth as Increased Net Social Welfare

The idea of net social welfare is where people are better off
than they were in the past. It measure both Economic and
Non-Economic factors.

Economic or Material Welfare is where people are better off

than in the past because they have more material possessions
than before i.e. more cars, more clothes etc.

Non-Economic Welfare however, means that because of the

increase in material possessions, these people now have to put
up with things like greater congestion and more pollution in
their everyday lives.

Net Social Welfare = Economic Welfare + Non-Economic Welfare

Growth as Increased Net Social Welfare

The ‘Economic’ Factors include the value of goods and services

produced alongside the environmental impact of this production
i.e. pollution caused, congestion caused but also public facilities
generated because of it also.
Net Social Welfare also includes income distribution,
affordability of housing and housing crowding.
However, it can be difficult to measure some non-economic
factors that contribute to the ‘quality of life’.
Different countries use different factors and measurements,
hence comparisons are also difficult.
Growth as Increased Net Social Welfare

HDI (Human Development Index) is a composite index

developed by the UN which is used to measure socio-economic
progress.

It has 3 components:
-Knowledge/Education (educational attainment, measured by
adult literacy)
- Longevity/Health (based on life expectancy)
- Income (standard of living based on Real GDP per Capita)

This has a combination of both social and economic data.

Strengths & Limitations of Net Social Welfare
as a Measure of Growth

Strengths:
- Includes economic welfare to indicate economy’s well-being.
- Takes into account the environmental impact.
- Availability of public facilities.

Weaknesses:
-Difficult to measure some factors that contribute to ‘happiness’
or well-being and may distort the overall measure.
-It may show an increase even though fewer goods and services
have been produced.
- International comparability is subjective.
 Rate of Economic Growth

The Rate of Economic Growth is the percentage change in

Real GDP.
The answer is expressed as a percentage growth rate.

Real GDP (Year 2) – Real GDP (Year 1)

Rate of
x 100
Economic Growth =
Real GDP (Year 1)
 GDP Per Capita

Real GDP gives an indication of the material standard of living

of an economy.
- Having more goods/services is usually interpreted as meaning
a higher standard of living.

However, this may not be so. Compare these two countries:

Country Real GDP ($b)

A 100
B 150
 GDP Per Capita

At first glance, you would think that the people living in

Country B are better off than those living in Country A, since
Real GDP is higher there.

However, what matters is how many people this GDP is spread

amongst.

Country Real GDP ($b) Population (million) Real GDP per Person ($)

A 100 5 20,000

B 150 10 15,000
 Limitations of GDP Per Capita

 The Distribution of Goods and Services

We don’t know how evenly income and wealth is spread
throughout the economy.
 Rates of Unemployment
An economy may be producing a large number of goods and
services, but may still have high unemployment.
 The Types of Goods being Produced
Demerit goods?
 The Composition of Growth
A large proportion of GDP may be used for negative aspects of
production i.e. to clean up pollution, caused by production.
 Models Illustrating Growth

Economic Growth can be illustrated through the use of Models:

- Production Possibility Curve
- Circular Flow Model
- AD/AS Model
 The Production Possibility Frontier

This model illustrates the concepts of scarcity, choice and

opportunity cost.

With this model, we assume:

• The economy produces only two goods.
• Resources are fixed in quantity.
• Technology is unchanging.
• The productivity of all resources is constant.
•All resources are used as efficiently as possible with the
existing levels of knowledge.
The Production Possibility Frontier

X = Resources being
Capital utilised to their
Goods Z
X maximum capacity
Y = Underutilisation of
Resources
Y X Z = Unobtainable level
of production with
current Resources

Consumer
Goods
 Productive Capacity

Increased productive capacity (or growth) can be achieved

when:
1. There is increased production of man-made capital
resources, that is investment.
2. The quantity or quality of human resources is increased
by:
– Increased population
– Increased working population
– Increased quality of resources through better
education, training or technological improvement
3. New natural resources are discovered
4. Improvements in technology are made
5. Net exports increase through increased trade
Increases in Production Possibility Frontier

 Discovery/Use of new
Capital Resources
Goods
PPF 3  Increase in Quality
or Quantity of Labour
 Investment

PPF 2
PPF 1

Consumer
Goods
 The Production Possibility Frontier

If a country chooses to produce more capital goods right now

than consumer goods; this will mean that it has a much greater
productive capacity in the future, than if it were to produce
more consumer goods than capital goods.

If a country chooses to produce more consumer goods right

now rather than capital goods; the population of the country
would enjoy greater consumption right now, but as a result will
not experience much economic growth, and therefore much
future consumption.
 The Production Possibility Frontier

Limitations of the PPF Model:

•The PPF is a theoretical curve and there is no practical way in
which the curve could be calculated.
•The curve is two-dimensional and unless groups of goods are
combined together (e.g. consumer goods and capital goods),
multiple combinations cannot be shown.
•Technology is constantly changing and this impacts
significantly on the productivity of resources.
•Resources are constantly changing as non-renewable
resources are used up and new resources are discovered.
Therefore the PPF is never constant.
 The Circular Flow Model – Recap
•The circular flow illustrates how the economy is connected
and the interdependence between sectors.
•The total value of the output of an economy can be obtained
by measuring the incomes earned in the production or the
spending on this same production.
•If we assume that all goods and services produced are
consumption goods, and that all income is spent on consumption
goods, then the value of spending on national income output
must always equal the value of incomes earned.
•Any changes in any of the flows in the circular flow model will
result in changes in national income.
•These flows are either directed into (injections) or out of
(withdrawals) the circular flow model.
 Growth and Circular Flow Model

Goods and Services National Output (GDP)

Consumption (C) = $150m

Households Firms

FOP

Incomes (Y) = $150m

Annual payment for using resources owned by households – wages,

rent, profit, and interest

National Income
 The Circular Flow Model

Injections: Withdrawals:
- Consumption Spending - Savings
- Investment - Taxes
- Export Receipts - Import Payments

• If injections > withdrawals, then national income will increase.

• If withdrawals > injections, the national income will decrease.
 AD/AS Model

The Aggregate Demand and Aggregate Supply Model is used to

illustrate the operation of an economy.
In this unit, we will use it to illustrate Economic Growth.
- When either AD or AS increases, this causes RGDP to
increase, which results in Economic Growth.
Reminder: AD is the total demand for goods and services in an
economy and is represented by: C + I + G + (X-M).
It is the quantity of national output that is purchased at a
given price level.
Unlike the GDP formula, which calculated the total value of
production in an economy (some of which may not be sold).
 Aggregate Demand

The Aggregate Demand curve will shift when any of the

components of the AD formula change: C I G (X-M).
-For example if Government announced an increase in
infrastructure spending, then G would increase causing AD
curve to shift outwards.
-Or if consumer confidence fell and they started to spend less
in the economy, then C would decrease, causing AD curve to
shift inwards.
 Aggregate Supply

The AS curve shows the real output that firms in the economy
are willing to supply at each price level.

At low levels of output, firms are willing to increase output with

a small increase in the price level as they have idle capacity.
The slope becomes steeper as much larger increases in price
are needed to entice firms to invest or add extra shifts and
pay overtime. As the economy approaches capacity, it is more
difficult to increase output as there is less spare capacity.
 Aggregate Supply

The AS curve will shift when:

•The Exchange Rate Appreciates/Depreciates or there is a

change in the World Price and the cost of Imported Raw
Materials.
•There is an increase/decrease in Productivity.
•The Costs of Production change.
• There is a change in Indirect Taxes or Government Charges.
• Remember the acronym EPIC
 Causes of Economic Growth

Discovery and Use of New Resources

- This could come from new energy sources or new technology etc.
Increase in the Quality or Quantity of Labour
-More workers could come from increased birth rates, increased
immigration or an increase in the labour force participation rate.
-Improving the quality of workers may come from better training and
skills, reorganising production and the workplace, improved attitudes
to work etc.
- Entrepreneurship (encouraging a ‘can do’ attitude).
Investment
-Thisis influenced by three key factors: Interest Rates, Business
Confidence and Costs involved in Investment.
 Why do Firms Invest?
The main factors firms consider when investing are:

1.Business Confidence
– If the firm has a positive outlook on the future then

confidence is high
2.Interest Rates involved in the investment
– Low interest rates will encourage investment

3.Costs vs Returns from the investment

– Expected returns from the investment must exceed

other uses of the money

The funds firm use to finance investment are household

savings (think back to the Circular Flow Model).
 Forms of Investment

Technology
is an improvement in methods, if methods improve then
outputs will increase, e.g new materials, new processes,
use of computers

Research and Development

discovering new ways to increase capital resources

Education
investment in human capital

Economic infrastructure is important for growth

e.g. transport, communications, energy, water. NZ has
problems in a number of these areas
 The Business/Trade Cycle

The business cycle

Peak
Economic Activity

Boom
Downturn
Upswing
Recession

Depression

Time
 The Business/Trade Cycle

• Boom – A peak in economic activity with unemployment

falling and inflation rising

• Recession – two consecutive quarters of negative

economic growth, with decreasing levels of investment
and output and rising unemployment

• Depression – a severe decline in the level of economic

activity. Output and investment are very low and there
is very high unemployment
 Effects of Economic Growth

Positive Effects:
• Increased employment.
•Increased household incomes, resulting from the increased
employment.
•Increased household consumption, as households spend their
extra income.
•Increased household savings, some of their extra income will
be put into savings or used to reduce debt.
•Extra investment and more growth, as demand for goods and
services increases, producers will make better use of their
existing capital resources and invest in new capital.
• Increased tax revenue for the government.
 Effects of Economic Growth

Negative Effects:
• Resource depletion, particularly natural resources.
• Environmental damage.
•Unwelcome social change e.g. in the Western world, heart
disease has become a far greater issue than it was in the 19th
century as our diets have changed to include greater quantities
of fatty foods.
• Inflation, increases in demand are likely to cause an increase
in prices.
•Uneven impact of growth, some areas may benefit more than
others.
 Impact of Major Events
Events like the Rugby World Cup or Americas Cup, being held in
NZ will generate additional spending in New Zealand

•Increased tourism with visitors spending more on services,

e.g. food and drink, hotels

•Increased spending by New Zealanders on rugby/sailing

related goods and services

•Increased spending on capital goods e.g. new or improved

stadiums/sailing facilities

•Increased demand for the New Zealand dollar from

tourists

•Impact may be uneven if the events are concentrated in

one region of the country i.e. Auckland
Government Economic Policies
(to support Growth)

Fiscal Monetary
Policy Policy

Government
Policies

Supply-Side
Microeconomic
Policy
 Fiscal Policy

Fiscal Policy involves changing government revenue and

expenditure to influence the level of economic activity.

Expansionary Fiscal Policy is where there is increased

government spending or reduced taxation in order to increase
the level of activity in the economy. It will increase AD as G >
T so there will be more money injected into the economy than
withdrawn.
Contractionary Fiscal Policy is where there is decreased
government spending or increased taxation in order to
decrease the level of activity in the economy. It will decrease
AD as T > G, withdrawals in this case are greater than
injections.
 Fiscal Policy - Taxes

Any action that the government takes to cut taxes will

initially stimulate economic activity:
-Direct tax cuts put more disposable income into consumers’
pockets and they will naturally spend some of this income.
- Therefore demand for goods and services in the economy will
increase. Resulting in increased production in the short-term
and an increased demand for labour.
- However, employees are then likely to demand higher wages
to compensate for their loss in purchasing power; if all else
remains the same, producer costs will rise, pushing the supply
curve for many goods to the left.
 Fiscal Policy - Spending

The government could spend money to stimulate the economy

on options such as:
• Increased welfare spending.
• Funding major public projects like motorways or hospitals.
• Increased spending on education.
• Funding more research and development.

However, the government can not spend enlessly – the Public

Finance Amendment Act 2004 can put a halt to excessive
government spending.

 Use the Internet to find out the key points of this act.
 Public Finance Amendment Act

Some of the key points are:

•Government debt must be at acceptable levels (less than 15%
of GDP). If debt is too high then the government must run
budget surpluses to reduce debt.
•Once debt levels are acceptable, the government should
maintain an operating balance (G=T) over the medium-term.
•The government should use generally accepted accounting
policies when presenting its accounts.
 Fiscal Policy

A government budget surplus occurs when the government’s

income is greater than its expenditure.
- This is contractionary fiscal policy.
- This is used to reduce levels of spending and decrease
aggregate demand.

A budget deficit is where spending exceeds income.

- This is expansionary fiscal policy.
- This would be used during a recession, depression or period
of stagnant economic activity.
 Monetary Policy

The government has given the Reserve Bank the task of

implementing monetary policy.
The goal of monetary policy according to the Reserve Bank
Act (1989) is price stability.

Changing interest rates has implications on the levels of

savings and investment and hence economic growth.
Lowering interest rates will increase investment, increasing
the level of economic activity and growth.
 Monetary Policy

The main tool the Reserve Bank uses to achieve price

stability is the official cash rate (OCR).
 The current rate is set at 8.25%

This is set by the Reserve Bank, which undertakes to:

 Pay interest of 0.25% less than the OCR to registered
banks on their cash deposits.
 Loan registered banks money at an interest rate of 0.25%
higher than the OCR.
This has the effect of controlling the retail interest rates
that the registered banks charge.
- This then affects the level of AD through consumer
spending and investment.
 Monetary Policy

The Reserve Bank can also use Expansionary or

Contractionary policies here.

Increasing the OCR is known as contractionary/tight

monetary policy.
Decreasing the OCR is known as expansionary/loose
monetary policy.
 Supply-Side Policies

Supply-side economics is the application of

microeconomic policies intended to increase Aggregate
Supply.

The NZ government aims to increase productivity and

efficiency in the economy, shifting aggregate supply to
the right, increasing output and growth.
 Supply-Side Policies

Supply-side policies refer to the government as a supplier of

goods and services.

From the mid-1980s the government began to question its role

as provider of many of its services. The belief was that the
private sector was a more efficient provider of these
services. Therefore a period of corporatisation, privitisation
and deregulation began.

- The Post Office was split into NZ Post, Post Bank and
Telecom.
- The financial sector was deregulated, by removing controls
on interest rates.
 Supply-Side Policies

In the trade sector, the government have removed some

subsidies and are phasing out tariffs with the aim of improving
the efficiency and competitiveness of NZ firms.

Gaining access to new markets through trade agreements, the

overall effect has been to promote trade and lead to greater
growth and the potential for growth in the future.
 Resource Management Act

One of the concerns of economic growth is its effect on

scarce resources and the environment.
The government put the Resource Management Act in place in
1991, that sets out how we should manage our environment.
The objective is to recognise ecological limits and promote
sustainable management of natural and physical resources .
Producers therefore must apply for resource consents. E.g.
Dairy Farmers must apply for resource consents to draw
water from rivers and streams in order to irrigate their
pasture and increase milk production.
- Obtaining a Resource Consent involves time and costs that
can often stall or even stop developments.
 Resource Management Act

Summary
The Resource Management Act:

~ Helps us to look after the environment.

~ Is based on the idea of the sustainable management of
natural and physical resources.
~ Encourages us to get involved in decisions about our
environment.