This chapter analyzes economic growth by examining the aggregate production function. Sources of economic growth are identified and growth rates of different countries are compared.
The Significance of Economic Growth
Growth in Output per Capita
Of course, it is not just how fast potential output grows that determines how fast the average person's material standard of living rises. For that purpose, we examine economic growth on a per capita basis. An economy's output per capita equals real GDP per person. If we let N equal population, then
Output per capita =
In the United States in the third quarter of 2010, for example, real GDP was $13,277.4 billion (annual rate). The U.S. population was 311.0 million. Real U.S. output per capita thus equaled $42,693.
We use output per capita as a gauge of an economy's material standard of living. If the economy's population is growing, then output must rise as rapidly as the population if output per capita is to remain unchanged. If, for example, population increases by 2%, then real GDP would have to rise by 2% to maintain the current level of output per capita. If real GDP rises by less than 2%, output per capita will fall. If real GDP rises by more than 2%, output per capita will rise. More generally, we can write:
% rate of growth of output per capita ≅ % rate of growth of output − % rate of growth of population
For economic growth to translate into a higher standard of living on average, economic growth must exceed population growth. From 1970 to 2004, for example, Sierra Leone's population grew at an annual rate of 2.1% per year, while its real GDP grew at an annual rate of 1.4%; its output per capita thus fell at a rate of 0.7% per year. Over the same period, Singapore's population grew at an annual rate of 2.1% per year, while its real GDP grew 7.4% per year. The resultant 5.3% annual growth in output per capita transformed Singapore from a relatively poor country to a country with the one of the highest per capita incomes in the world.