Economic Growth

Economic GrowthMeasures of Economic GrowthEconomic growth is defined as the percentage change in an economys GDP or GNP values. It is an indicator of an economys progress

A closely related concept is the growth rate of output per person, indicative of an economys standard of livingQuarterly GDP Growth Rate, June 2014Ratio of GNI per Capita to GNI, 2013Factors Affecting Growth RatesPhysical factorsClimateNatural resourcesLocationNatural hazardsPolitical factorsTradeCorruption / poor managementWarSocial factorsDiscriminationPopulationProduction Possibility Frontier (PPF)The PPF shows the maximum quantity of goods that can be produced efficiently by an economy given its technological knowledge and the quantity of available inputs.

PPF & Economic GrowthEconomic growth occurs when a countrys PPF shifts outward.

Public vs. private goods

Luxury vs. necessary goods

Consumption vs. investment goods

ProductivityProductivity is defined as the ratio of output to a weighted average of inputsFour determinants of productivityHuman resources (L)Capital resources (K)Natural Resources or Land (R) Technological change and innovation (T)Aggregate Production Function (APF)Q = f (K, L, R, T)

Alternatively, Q = f (K, L) where R forms a part of K and T is assumed to be fixed.

L grows at a given or constant rate

Capital deepening, an important driver of growth, is defined as the capital-labour ratio or quantity of capital per worker APFAs capital deepening takes place for a given technology, the increase in output-labour ratio becomes smaller because of diminishing returns to capital

APF & Technological ChangeIn the long run without a technological change, the capital-labour ratio will stop rising, the economy will enter a steady state in which capital deepening ceases, real wages stop growing, returns to capital are constant.If economic growth consists of only accumulating capital with existing methods of production, without any technological change, then economic growth will stagnate and the standard of living will stop rising.APF shifts when new technology is augmented & the growth process is reinvigorated.Cobb-Douglas Production FunctionQt = Tt Kt Lt

gQ = gT + gK + gLg denotes growth rates is the partial elasticity of output with respect to capital is partial elasticity of output with respect to labour + > 1 increasing returns to scale + = 1 constant returns to scale for, and + < 1 decreasing returns to scale for

Total Factor Productivity (TFP)TFP is defined as the change in output caused by change in technological innovationIt is the portion of output not explained by the amount of inputs used in productionIt is measured using Solow residuals under the assumptions:production function is neoclassicalthere is perfect competition in factor marketsthe growth rates of the inputs are measured accuratelySolow ResidualA constrained Cobb-Douglas Production Function has + = 1 or = 1

Solow residual is defined asgT = gQ gK (1 ) gLIndian Scenario

Reasons for Decline in TFPAdministrative and bureaucratic tanglesPoor infrastructureBarriers to investmentUnskilled labour forceLack of innovationPersistent inflationCurrent account deficit, and Slow growth in private investment

Savings and Investment RatesAnnual Growth Rate of TFP by Broad Sector, 1980 2008Broad SectorsTotal Factor ProductivityAgriculture, Hunting, Forestry, Fishing1.68Mining & Quarrying-0.17Manufacturing1.30Electricity, Gas & Water Supply2.62Construction-3.31Services2.07Total Economy1.74