Economic growth is an increase in an economy’s real output over time, most commonly measured by the growth rate of real GDP or real GDP per capita.
Measuring Growth
If \(Y_t\) is real GDP, a simple growth rate is:
\[ g_t = \frac{Y_t - Y_{t-1}}{Y_{t-1}} \]
Economists often use log differences for approximation:
\[ g_t \approx \ln(Y_t) - \ln(Y_{t-1}) \]
Real GDP per capita matters for living standards:
growth in GDP per capita ≈ GDP growth - population growth (roughly, when rates are small).
What Drives Long-Run Growth
A standard way to organize the logic is a production function, for example:
\[ Y = A K^{\alpha} L^{1-\alpha} \]
where:
- \(K\) is capital (machines, structures),
- \(L\) is labor (hours, skills),
- \(A\) is total factor productivity (technology, organization, institutions).
Growth accounting uses this to decompose output growth into contributions from capital deepening, labor growth, and productivity growth.
In the Solow growth model, capital accumulation can raise output for a while, but due to diminishing returns sustained long-run growth in output per worker is tied to growth in \(A\) (productivity/technology).
Growth vs. The Business Cycle
Economic growth is a long-run trend. The business cycle is short-run fluctuation around that trend (recessions and expansions). Demand management can strongly affect short-run output, while long-run growth depends more on productivity and factor accumulation.
Related Terms
- Gross Domestic Product (GDP)
- Real GDP
- GDP Deflator
- Business Cycle
- Solow Growth Model
- Solow Residual
- Total Factor Productivity
- Productivity
- Capital Accumulation