GDP GROWTH vs Economic Growth (Decline)

GDP GROWTH vs Economic Growth (Decline) “You cup runeth over---or not…”

GDP GROWTH vs. Economic Growth (Decline) • GDP measures the production of goods and services in a given time period • Real GDP measures the production of goods and services in given time period holding prices constant • Economic Growth is the overall ability of an economy to INCREASE its POTENTIAL to produce goods and services given its productive resources • Economic Decline is the overall ability of an economy to DECREASE its POTENTAL to produce goods and services given is productive resources

GDP GROWTH vs. Economic Growth (Decline) • Using a Container (Cup, Bucket, whatever…) will illustrate the difference between Changes in GDP and changes in Economic Growth (Decline). • Think of GDP as being a “FLOW”---it increases and/or decreases over time—it is variable • Think of Economic Growth (Decline) as a “STOCK”- it is relatively fixed in the SHORT-RUN but can EXPAND or CONTRACT in the LONG-RUN.

This container is of a certain size and volume. It will only hold so much water….

If we fill this container to the TOP we will have reached it’s CAPACITY to hold water. It will not hold anymore water UNLESS we alter the size of the container to increase it’s capacity…

Now assume the container springs a leak and the level of water in the container DECREASES.

Has the CAPACITY of this container to hold water INCREASED, DECREASED, or STAYED THE SAME???

It has STAYED THE SAME…We now simply have less water in it…

We have unused capacity in the container now. It is only half-full.

Now lets plug the leak and put water BACK INTO the container

Now we are back to having a FULL Container

Now that the container is full AGAIN, can we say that have “grown” the size of the container? No, we have simply moved from a lower level of water to a higher level of water---the container has not grown at all---only the contents have expanded of contracted….The container did not “grow” or “Shrink”. BIG DEAL, right??? What does this have to do with anything?

Assume the container represents the productive capacity of the economy. Using our productive resources in the least costly way (Productive Efficiency). If we are at productive efficiency we can fill up the container with Goods and Services

Now assume something happens in the economy (oh, ummm, a financial crisis) and the economy goes into a recession (workers laid off don’t buy goods and services then business have to lay-off more workers, so on an so forth…) So our production of goods and services DECREASES. In other words, the economy springs a leak

Did the ability of this economy to produce goods and services decrease or are we just under-utilizing the productive capacity of the economy??? Think of the water example we started out with…

In the short run we are under-utilizing our resources (most important one is people). In this scenario we do not have economic decline because we still have productive capacity to use when things get better…

If we “plug the leak” of what ails the economy and we start to produce more goods and services we can fill the container back up with goods and services, and put people back to work.

We produced more goods and services to get back to full capacity---does this mean we experienced “economic growth”? Think of the water container example---when we filled the container up did we increase the size of the container or did we just utilize unused capacity?

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy---the ability to produce MORE goods and services.

ECOMOMIC GROWTH • When there is a recession and you hear that the economy is “growing” or we are experiencing “economic growth” you have to be careful in interpreting that. • In Economics, Economic Growth is the INCREASING of the PRODUCTIVE CAPACITY of the Economy for the long term---not the increasing of GDP in any given point in the short run….

GDP GROWTH vs Economic Growth (Decline)