Define economic growth and GDP, explain its causes, and assess its link to the standard of living

What this dot point is asking

The syllabus wants you to define economic growth and gross domestic product, explain what causes growth, and assess how well growth measures the standard of living. The big idea is that growth means producing more, which usually raises living standards, but GDP is an imperfect measure and more output does not always mean people are better off.

The answer

What economic growth and GDP are

We use real GDP, which removes the effect of inflation, so that growth measures a genuine rise in the quantity of output, not just higher prices.

The causes of economic growth

An economy grows for the same reasons its production possibility curve shifts outward:

• More resources. A larger workforce (from population growth or immigration) or more capital (new factories and machines) lets the economy produce more.
• Better resources or technology. Better-educated, healthier and better-trained workers, or improved technology, raise productivity, so the same resources produce more output.
• Higher aggregate demand. If there are spare resources (unemployment), a rise in spending can put them to work, raising output toward the economy's capacity.

Why GDP per head is used for living standards

To judge the standard of living, economists usually look at GDP per head (GDP divided by the population), not total GDP. This is because:

• A country with a large GDP but a huge population may have a low GDP per head, so the average person is not well off.
• Growth only raises living standards if output rises faster than the population.

The limitations of GDP as a measure of wellbeing

A higher GDP does not always mean people are better off, for several reasons:

• Population. If population grows as fast as GDP, GDP per head does not rise.
• Distribution. GDP says nothing about how income is shared; growth may benefit only a few.
• Quality of life and external costs. Growth can bring pollution, congestion and stress, which lower wellbeing but are not subtracted from GDP.
• Non-market activity. GDP misses unpaid work (such as caring at home) and the value of leisure.

Examples in context

Example 1. Singapore's growth and rising living standards. Singapore grew rapidly over decades by raising productivity through education, investment and technology. Because output grew faster than population, real GDP per head rose strongly, lifting average living standards, a clear case of growth improving wellbeing.

Example 2. Growth with congestion and pollution. Rapid growth in many cities has come with worse traffic congestion and air pollution. These costs lower the quality of life but are not subtracted from GDP, illustrating why GDP overstates how much better off people become as an economy grows.

Try this

• Cue. Define economic growth. An increase in the output of goods and services in an economy over time, usually measured as a rise in real GDP.

• Cue. Explain why GDP per head is used to judge living standards rather than total GDP. GDP per head divides output by the population, so it shows the average person's share; total GDP can be large simply because the population is large.

• Cue. State two reasons a rise in GDP may not make people better off. Any two of: the population may rise just as fast (so GDP per head does not rise); the extra income may be unequally shared; or growth may bring pollution and other costs that lower the quality of life.