The Basics of Economic Growth
• The economic growth rate is the annual percentage change of real GDP.
• The standard of living depends on real GDP per person, which is real GDP divided by the
• Sustained growth of real GDP per person can transform a poor society into a wealthy one.
• We calculate how many years it takes for the level of any variable, including real GDP per person,
to double, by using the Rule of 70.
• The Rule of 70 states that the number of years it takes for the level of any variable to double is
approximately 70 divided by the annual percentage growth rate of the variable.
Long--Term Growth Trends
• Long-term growth trends are the trends in potenial GDP.
• Check out Figure 22.2 on p. 518 of your textbook to study real GDP per person in Canada between
1926 and 2007.
• During this period, real GDP per person grew 2.1 percent a year, on the average.
• Real GDP growth has been similar in Canada, the Europe Big 4 (France, Germany, Italy, and the
United Kingdom), and the United States since 1960. Growth in Japan was very rapid during the
1960s, slower during the 1980s, and even slower during the 1990s.
Changes in Potential GDP
• Potential GDP increases if there is an increase in population or an increase in labour productivity.
• An increase in population increases the supply of labour.
• In the figure, the labour supply curve shifts rightward from L0 to LS1, the real wage decreases and
the quantity of labour employed at full employment increases.
In the figure below, the increase in the full-employment level of labour increases
potential GDP from $1,000 billion to $1,300 billion along the production function. • With an increase in population, potential GDP per hour of work decreases.
• Initially, with potential GDP at $1,000 billion and labour hours at 20 billion, potential GDP
per hour of work was $50.
• With the increase in population, potential GDP is $1,300 billion and labour hours are 30
billion, and potential GDP per hour of work is $43.33.
• Diminishing returns are the source of the decrease in potential GDP per hour of work. • Labour productivity is the quantity of real GDP produced by an hour of labour, calculated
by dividing real GDP by aggregate labour hours.
• Labour productivity increases if there is:
o An increase in physical capital
o An increase in human capital
o An advance in technology
• In the figure below, an increase in labour productivity increases the demand for labour,
and the demand for labour curve shifts rightward from LD to LD .
• The real wage rate rises from $35 an hour to $45 an hour and the full employment
quantity of labour increases from 20 billion hours to 22.5 billion hours.
• The production function shifts upward and potential GDP increases from $1,000 billion to
$1,500 billion. Potential GDP per hour of work also increases from $50 to $66.67. • The purpose of growth accounting is to calculate how much real GDP growth results
from growth of labour and capital and how much is attributable to technological
• The law of diminishing returns states that as the quantity of one input incr