International Maarif School of Ethiopia, Grade 10th Economics By : Taju Aman Page 1

UNIT 6
Economic Growth
Introduction
In this unit of grade 10th economics text book, we will discuss “macroeconomic variables, defi-
nition and measurement of economic growth, sources of economic growth: economic factors and
non-economic factors, why growth varies across economies, classification of countries by income
levels: Low income, middle income and upper income, measurement of productivity, the effect of
productivity on economic growth, the weaknesses of using GDP/GDP Per Capita, and the business
cycle: its definition and phases”.

Unit objectives
♡ Identify the major sources of economic growth.
♡ Explain the different phases of business cycles.
♡ Discuss about alternative ways of measuring economic growth
6.1 Macroeconomic Variables

Macroeconomic Variables

Economics is a social science that deals with making decisions of getting the best out of the
limited resources that we have. If these decisions are made at individual decision makers level, the
analysis will be categorized under microeconomics. If on the other hand, these decisions are made
at a country level, and the analysis will be categorized under macroeconomics. Microeconomics
gives a good analysis of how much the consumer should consume (buy) with the available budget.
Similarly, the producer decides on the quantity of input used in the production process to maximize
profit from the goods and services produced with the limited factors of production available. This
is known in economics as optimization.
Nations make decisions through their governments or leaders. The endowments of countries such
as land, forest, water, population, machineries, capital, etc. are limited. If not used economically,
they will be wasted without attaining the macroeconomic goals.Macroeconomics is the best tool
available in making the decision of giving priorities in production and consumption at country level
so that we attain the macroeconomic goals. These macroeconomic decisions are made through
government macroeconomic policies.
The major macroeconomic variables include: Current Account Balance, Inflation, Economic Growth
and Unemployment. On the other hand, the major macroeconomic goals pursued by governments
of countries are; improved current account balance; stable prices; increased economic growth; and
reduced unemployment.
I . Current Account Balance: Current account balance is the difference between the dollar
value of goods a country exports and the dollar value of goods a country imports. ˆ Therefore,

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current account or trade balance = Exports (X) – Imports (M).

There will be two scenarios:

Scenario 1: If the value of exports (X) is greater than the value of imports (M), there is a trade
surplus. This is a desirable outcome.
Scenario 2: If the value of exports (X) is less than the value of imports (M), there is a trade deficit.
This is not a desirable outcome.
II . Inflation: is an increase in the overall price level of goods and services over a certain period
of time. When there is inflation, there will be a fall in purchasing power of currencies over time.
High inflation is not desirable in an economy. This would mean that policymakers try and keep
inflation low.
There are two types (causes) of inflation;
• Cost-push inflation: when the costs of production is high producers increase price to be prof-
itable; and
•Demand-pull inflation: when growing demand (being able to pay higher prices) for goods that
firms produce, allowing firms to even increase prices to gain more profit.

III . Economic growth: is the amount that the level of output within an economy increases over
a given time period usually a year. Economic growth is extremely desirable since it means that,
the people within an economy are getting richer. Economic growth can be increased in a number
of ways, such as technological improvement, an increase in the demand for goods and services, and
an increase in the size of the workforce.

IV . Unemployment: refers to the number of people within an economy who are willing and
able to work, but do not have a job at the going wage rate. There are a number of different types
of unemployment: frictional unemployment; - caused by the search for a new job or a transition
between jobs; structural unemployment; - caused by the decline of a specific industry, for example
type-writing or coal mining; seasonal unemployment; - caused by the time of year, drought time
for farmers; and cyclical unemployment; - caused by a recession – a reduction in the level of output
within an economy.
6.2 Definition and Measurement of Economic Growths

6.2.1 Definition and measurement of Economic Growth

Economic growth in the short run is when RGDP increases in the short run. Increase in RGDP is
given by the following formula:
RGDPt−RGDPt−1
g= RGDP−1
x100%
Economic growth in the long run, is when there is a sustained increase in per capita income and
associated structural changes in the economy. That means GDP increase for subsequent years and
Structural change from agricultural sector to manufacturing sector also takes place. Per capita
real GDP, also known as Per Capita Income, is given by the following formula. It is the RGDP of
the given year divided by the total population of the year.
RGDP t
Per capita RGDP = Population t

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Sources of economic growth in an economy

Economic growth comes when resources are recreated, reorganized and reallocated in a more effi-
cient manner. Technological improvement brings economic growth since it increases productivity.
Imagine using tractors rather than oxen for farming.The others are the factors of production;
increases in the factors of production like land, labor and capital bring economic growth.
Higher growth rate of the GDP (economic growth) is taken as basic for improving living standard,
alleviating poverty, creating more employment opportunities and greater social security. The level
of real GDP is a good indicator of economic prosperity, and the growth of real GDP is a good
indicator of economic progress. Growth rate measures how rapidly real GDP per person grew in
the typical year.
6.2.2 Economic growth vs Economic development

Growth refers to the rate of increase in GDP or GDP per capita. Development, on the other
hand, refers to a much broader concept that applies to a process of overall transformation in
different aspects of human life. It deals with progressive changes in social, political, institutional
and economic structures. Economic growth can take place without economic development but for
economic development to take place economic growth is a necessary but not a sufficient condition.
6.3 Sources of Economic Growth

In richer countries’ (such as; the United States, Japan, or Germany) average income, is more than
ten times the average income of poor countries (such as India, Indonesia, or Nigeria).People in
richer countries have better nutrition, safer housing, better healthcare, and longer life expectancy
as well as more automobiles, more telephones, and more televisions. Recently, some East Asian
countries, such as Singapore, South Korea, and Taiwan, have achieved economic growth of about
seven percent (7income doubles every ten (10) years. Even more recently, China has enjoyed an
even higher rate of growth—about twelve percent (12such rapid growth can, in one generation, go
from being among the poorest in the world to being among the richest.
What sets apart rich countries from poor countries?

Tthe key distinctive feature that sets apart rich from poor countries is their respective productive
structures and the specific characteristics of the products that they export. These, in turn, depend
on the capabilities that firms possess. Development in this paradigm is a process of accumulating
capabilities, generating new activities and letting others disappear.
The neoclassical theory predicted that poor countries would grow faster than wealthy countries,
because of technological advances and diminishing returns to capital in the latter. However, the
reverse has occurred: poor countries are falling back rather than catching up. Kefer and Knack
suggested that deficient institutions in the poor countries is the reason for falling back rather
than catching up. The indicators for deficient institutions in the poor countries include lack of
institutional quality, including the rule of law, the pervasiveness of corruption, and the risk of
expropriation and contract repudiation. They argued that the ability of poor countries to catch
up is determined in large part by the institutional environment in which economic activity in these
countries takes place.

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6.3.1 Economic growth Around the world

The data on real GDP per person show that living standards vary widely from country to country.
Income per person in the United States, for instance, is about eight (8) times than that in China
and about sixteen (16) times that in India. The poorest countries have an average level of income
that is not seen in the developed world for many decades. The typical citizens of India in 2008 had
less real income than the typical residents of England in 1870. The typical person in Bangladesh
in 2008 had about two-thirds the real income of a typical American a century ago.
Table 6.1 World Economic Growth Experience
Real GDP Per Person at the Average Economic
Country Period
beginning of the period* Growth rate
Japan 1890 − 2008 $1504 2.71%
Brazil 1900 − 2008 779 2.40
Mexico 1900 − 2008 1159 2.35
Germany 1870 − 2008 2184 2.05
Canada 1870 − 2008 2375 1.99
China 1900 − 2008 716 1.99
United States 1870 − 2008 4007 1.80
Argentina 1900 − 2008 2293 1.69
United
1870 − 2008 4808 1.47
Kingdom
India 1900 − 2008 675 1.38
Indonesia 1900 − 2008 891 1.36
Pakistan 1900 − 2008 737 1.21
Bangladesh 1900 − 2008 623 0.78
The average growth rate measures how rapidly real GDP per person grew in the typical year.
In the United States, for example, where real GDP per person was 4, 007in1870and46,970 in
2008, the average growth rate was 1.80 percent per year. This means that if real GDP per person,
beginning at 4, 007, weretoincreaseby1.80percentf oreachof 138years, itwouldendupat46,970. This
means that real GDP per person did not actually rise exactly 1.80 percent every year: Some years
it rose by more, other years it rose by less, and in still other years it fell.
The countries in Table 6.1 are put in order by their growth rate from the most to the least rapid.
With a growth rate of 2.71 percent per year, Japan tops the list. A hundred years ago, Japan was
not a rich country. Japan’s average income was only somewhat higher than Mexico’s, and it was
well behind Argentina’s. The standard of living in Japan in 1890 was less than half of that in India
today. But because of its spectacular growth, Japan is now an economic superpower, having an
average income more than twice that of Mexico and Argentina and similar to Germany, Canada,
and the United Kingdom. At the bottom of the list of countries are Pakistan and Bangladesh,
which have experienced a growth of less than 1.3 percent per year over the past century. As aresult,
the typical residents of these countries continue to live in abject poverty.
6.3.2 Productivity as cause for differences in living standards among countries
Why productivity is so important: Productivity’s key role in determining living standards is
as true for nations as it is for stranded sailors (Robinson Crusoe). An economy’s gross domestic
product (GDP) measures two things at once: the total income earned by everyone in the economy
and the total expenditure on the economy’s output of goods and services. GDP can measure these

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two things simultaneously because, for the economy as a whole, they must be equal. Put simply, an
economy’s income is the economy’s output. A nation can enjoy a high standard of living only if it
can produce a large quantity of goods and services. Americans live better than Nigerians because
American workers are more productive than Nigerian workers. The Japanese have enjoyed more
rapid growth in living standards than Argentineans because Japanese workers have experienced
more rapid growth in productivity.
How productivity is determined:

I . Physical capital Per worker - Workers are more productive if they have tools with which
to work. Physical capital per worker is the amount of tools and machineries available for each
worker to work with.

II . Human Capital Per Worker - A second determinant of productivity is human capital.

Human capital is the economist’s term for the knowledge and skills that workers acquire through
education, training, and experience. Human capital includes the skills accumulated in early child-
hood programs, grade school, high school, college, and on-the-job training for adults in the labor
force. Producing human capital requires inputs in the form of teachers, libraries, and student time.

III . Natural Resources Per worker - A third determinant of productivity is natural resource.
Natural resources are inputs into production that are provided by nature, such as land, rivers, and
mineral deposits. Differences in natural resources are responsible for some of the differences in
standards of living around the world. The historical success of the United States was driven in
part by the large supply of land well suited for agriculture. Today, some countries in the Middle
East, such as Kuwait and Saudi Arabia, are rich simply because they happen to be on top of some
of the largest pools of oil in the world. Although natural resources can be important, they are
not necessary for an economy to be highly productive in producing goods and services. Japan,
for instance, is one of the richest countries in the world, despite having few natural resources.
International trade makes Japan’s success possible. Japan imports many of the natural resources
it needs, such as oil, and exports its manufactured goods to economies rich in natural resources.
IV . Technological Knowledge- A fourth determinant of productivity is technological knowl-
edge—the understanding of the best ways to produce goods and services. A hundred years ago,
most Americans worked on farms because farm technology required a high input of labor to feed
the entire population. Today, thanks to advances in farming technology, a small fraction of the
population can produce enough food to feed the entire country. This technological change made
labor available to produce other goods and services.
6.3.3 Characteristics of Economic Growth

Simon Kuznets, a renowned Economist and the father of national income accounting, identified
five major characteristics of modern economic growth:
a) High rates of increase in per capita income: Modern economic growth essentially means
high rates of growth of per capita income over a fairly long period of time.
b) High rates of increase in factor productivity: Modern economic growth also requires
increase in the productivity of all the factors of production.
c) High rates of structural transformation: Modern economic growth requires a shift in

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the economic activities from less productive (agricultural) to more productive (industrial) areas.
Growth of the entrepreneurial class, which has the desire and capacity to undertake new economic
activities, is an essential prerequisite for structural transformation to take place.
d) Increase in the rates of saving and investment: Economic growth takes place when the
domestic saving and investment rates rise. The establishment and expansion of modern financial
services is necessary for mobilizing domestic resources.
e) Increasing application of modern scientific knowledge in the production process:
Application of scientific knowledge in the production process increases the efficiency of resource
utilization and besides provides substitutes for the resources that are scarce.
6.3.4 Categories of the world countries according to Income
The most common way to define the world countries is by their per capita income as developed
and developing. Several international agencies, including the Organization for Economic Cooper-
ation and Development (OECD) and the United Nations, offer classifications of countries by their
economic status measured by their per capita income into the above two groups: developed and
developing. In the World Bank’s classification system, 210 economies with a population of at least
30,000 are ranked by their levels of gross national income (GNI) per capita. These economies are
then classified as;
1. low-income countries (LICs):- defined as having a per capita gross national income in
2008 of 975orless,
2. lower middle- income countries (LMCs): have incomes between 976and3,855,
3. upper-middle-income countries (UMCs): have incomes between 3, 856and11,906,
4. high-income OECD countries, and other high-income countries: have incomes of
11, 907ormore.
The United Nations, as of 2010, categorize a group of countries with low income, low human capi-
tal, and high economic vulnerability as the Least Developed Countries (LDCs). This classification
includes 49 countries of the world; 33 in Africa, 15 in Asia, plus Haiti.

6.4 The Weaknesses of Using GDP/GDP Per Capita

GDP measures both the economy’s total income and the economy’s total expenditure on goods
and services. Thus, GDP per person tells us the income and expenditure of the average person in
the economy.The following are the limitations of GDP as a measure of economic performance of a
nation;
GDP, however, is not a perfect measure of well-being: Some things that contribute to a
good life are left out of GDP. One is leisure. Suppose, for instance, that everyone in the economy
suddenly started working every day of the week, rather than enjoying leisure on weekends. More
goods and services would be produced, and GDP would rise. Yet despite the increase in GDP, we
should not conclude that everyone would be better off. The loss from reduced leisure would offset
the gain from producing and consuming a greater quantity of goods and services.
Because GDP uses market prices to value goods and services, it excludes the value of almost
all activity that takes place outside markets. In particular, GDP omits the value of goods
and services produced at home. When a chef prepares a delicious meal and sells it at his restaurant,
the value of that meal is part of GDP. But if the chef prepares the same meal for his family, the
value he has added to the raw ingredients is left out of GDP. Similarly, child care provided in

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day-care centers is part of GDP, whereas child care by parents at home is not. Volunteer work also
contributes to the well-being of those in society, but GDP does not reflect these contributions.
Another thing that GDP excludes is the quality of the environment. Imagine that the gov-
ernment eliminated all environmental regulations. Firms could then produce goods and services
without considering the pollution they create, and GDP might rise. Yet well-being would most
likely fall. The deterioration in the quality of air and water would more than offset the gains from
greater production.
textitGDP also says nothing about the distribution of income. A society in which 100
people have annual incomes of 50, 000hasGDP of 5 million and, not surprisingly, GDP per person of
50, 000.Sodoesasocietyinwhich10peopleearn500,000 and 90 suffer with nothing at all. Few people
would look at those two situations and call them equivalent. GDP per person tells us what happens
to the average person, but behind the average lies a large variety of personal experiences.
textitGDP also excludes those transactions that take place in Black markets. Their
transactions are valuable to the society’s well-being but since they are illegal, they will not be
counted in the GDP.
6.5 The Business Cycle and Its Phases

The Business Cycle and its Phases

Economic fluctuations are not at all regular, and they are almost impossible to predict with much
accuracy. Thus, Business cycle: is the irregular and largely unpredictable fluctuations in economic
activity, as measured by the production of goods and services or the number of people employed.
Phases of the business cycle: Changes in aggregate demand bring about changes in the level of
output, employment, income and price. These changes are generally cyclical in nature and follow
a cycle of four different phases:

ˆ Prosperity or boom;
ˆ Recession;
ˆ Depression or slump; and
ˆ Recovery.
I . Prosperity or boom or peak: is a phase of economic activity characterized by rising de-
mand, rising prices, rising investment, rising employment, rising incomes, rising purchasing power
and hence rising demand and so on. The investors, therefore, voluntarily undertake risks and go
in for investment. These further fuels boom conditions through the working of the multiplier effect.

II . Recession: during the boom period, the economy may get over- heated and the monetary
authorities, the financial institutions and the business itself may begin to play cautious. There
may be cuts in investment, resulting in cuts in employment, fall in incomes, decline in purchasing
power and demand. Prices may begin to fall.
III . Depression or slump or trough: if the effective corrective measures cannot be undertaken,
the economy may find itself go into depression. It is a stage when the business confidence is at its

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lowest. Investment, employment, output, income and prices touch the bottom.

IV . Recovery or expansion: as the economy moves out of depression, it enters the phase of
recovery. Sustained recovery will find the level of investment, employment, output, income and
prices moving upwards. This may finally result in boom conditions in the economy.

Figure 1:

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