Difference between Actual Growth and Potential Growth - Essay Example

? ECONOMICS Difference between actual growth and potential growth …………………. College/ ………….. …………. Introduction Countries differ greatly in relation to the economic growth, standard of living and income of its people. Some countries grow rich and some others remain poor and this has been a central topic of debates for several decades. Economists use real income per capita in order to measure the well being of the people in a country. When it come to the economic growth, not only peoples’ income but also many other factors like political freedom, education, health and environment are of greater significance. This piece of research paper defines potential growth and actual growth and explains the basic differences between them based on the literatures. This paper described how governments can influence both actual and potential growth of a country through demand and supply variables. Definitions of Potential and real growth Economic growth in simple term is an increase in a country’s output. Actual growth has been defined as an economic growth which is measured as a rate at which the real GDP- Gross Domestic Product- is changing. A country may be able to produce more quantity of goods and services and thus its potential will increase due to an increase in the quantity or quality of its resources. This is referred as potential growth (Grant and Vidler, p. 142). Thus, actual growth refers to the increase in the output of a country whereas potential growth is an increase in a country’s ability to produce goods and services with the resources it has. As Katz (p. 30) defined, potential growth is the rate that an economy can sustain over the long haul by operating in full capacity. Actual growth is the exact change or growth in the economy as a result of the real GDP growth or change. Actual growth occurs when the resources and factors of production are increased and as a result the actual output has been increased. The total output of a country measured in total income or quantities of the goods and services it produced may change over time even when there are no change in the resources. If it is assumed that the quantity and quality of the available resources are fixed in a country, the production possibility curve can still shift its positions as the maximum potential output of that country may change. When the resources are fixed in a specific time period, they can do possibly change over time. A good example for this can be illustrated from a country’s growing population. When its population grows, it will directly cause increase in the supplies of labors and entrepreneurial skills etc and most probably labor quality also improve over time. Apart from these, the country would probably become able to increase its stock of capital, improve the existing energy, mineral and related resources etc. As a result of the increase in these factors of production in the country, its ability to produce more outputs will also increase and it refers to the potential growth (McConnell and Brue, p. 29). Differences between Actual Growth and Potential Growth The basic difference between actual growth and potential growth is that, as detailed above, actual growth refers to the growth in the economy being measured as a rate at which the real GDP is changing whereas potential growth refers to a country’s ability to produce more being its production possibility is more due to an increase in its factors of production (Samuelson, p. 469). From the view of economists, the potential or full-employment growth rate is an estimate of how much supply of goods and services that the country produces would be expanding if all the available or existing factors of production were fully utilized (Baumol and Blinder, p. 136). Actual growth measures the demand for goods and services within the country, and the demand for them may be less than the potential supply. Some factors in this case may be underused (Lincoln, p. 26). When a country is accessible to larger quantities of resources, its potential to produce more will be possible. The society thus will be able to achieve economic growth in a way of expanded potential output. As McConnell and Brue (p. 29) stressed, such a favorable change in the production possibility curve may not guarantee that the economy will operate at a point in its new production possibility curve. As of some reports, around 137 million jobs would be able to give full employment to the US as of 2003, but after few years from 2003, 137 million jobs would never be sufficient to for its fuller employment. This illustrates that the production possibility curve may shift, but in a future time, the economy may fail to produce at a point on that particular new curve. In the short run, the main determinant of variations in the rate of actual growth is aggregate demand. Aggregate demand is the total spending on goods and services made in a country within a particular period of time. Sloman (p. 581) argued that aggregate demand and actual output fluctuate together in the short run. When there is a rapid rise in the aggregate demand, there can be a boom effect because, the faster the increase in the aggregate demand, the higher the short term rate of actual growth. When there is reduction in aggregate demand, it is more likely to cause recession in the economy. The diagram given below shows potential growth that occurs with the production possibility point that remained unchanged. In the long run, the productive potential of the country must be increasing in order the economic growth to be continued. If this is not the condition, the economy will more likely to hit a supply constant being unable to produce any more with the available quantity of resources and with the existing quality levels too (Grant and Vidler, p. 142). When the actual output is below the potential output, the actual output curve would slope upward more steeply than the potential output curve. If the gap between the curves of actual output and potential output are closed, the actual output curve will slope as steeply as the potential output curve, because the two curves cannot cross. Actual output curve can never be above the potential output curve. The two determinants of the actual growth in the long run, there fore, are a) the growth in aggregate demand and b) the growth in the potential output (Sloman, p. 580). McConnell and Brue (p. 30) detailed that the production possibility curve will move outward and to the right due to increase in supplies of the resources, the improvements in the resources qualities and more specifically technological advances. The concept of potential growth assumes constant and unchanging technology. The technology changes and becomes highly advanced over time resulting improved ways of producing goods and services. Actual growth can thus be measured by considering the advances in technology such as computerization and other recent improvements. The potential growth instead assumed the the technology does not change and with the existing technology how more quantities of goods or services can be produced or with more quality. Government’s influence on actual and potential growth through demand and supply variables Actual out put will match potential output only when the aggregate demand matches the full employment level of the aggregate supply. This is the condition where the economy will be able to make the maximum output that it is able to. But, when there is a lack of aggregate demand there can be unemployed resources and this causes an output gap, as illustrated in the diagram. This output gap causes severe troubles on the economy and is more or less a consequence of the rising inflation (Denison, p. 5). The government can influence the levels of both actual and potential growth through supply and demand variables. For instance, the recent economic crisis started from the US in 2008 had significant impact on global potential output. Many countries including the US have boosted the local productivity and growth by easy credit conditions and reallocation of resources that in turn gave rise to the economic growth (Gros and Alcidi, p. 11). Conclusion This piece of research paper has presented a brief study about actual growth and potential growth, including definitions and explanations to how they both differ based on various literatures in the Economics. This paper has highlighted that actual growth refers to the economic growth being measured as a rate at which the real GDP is changing and potential growth is the ability of a country to produce more by maximum utilizing the fixed resources the country has. This paper found that the output gap between the actual and potential growth can cause significant impacts on the economy and the government can influence both actual and potential output by measures of demand and supply. References Baumol, WJ & Blinder, AS, Macroeconomics: Principles and Policy, Eleventh Edition, Cengage Learning, 2010 Denison, EF, Trends in American economic growth, 1929-1982, Brookings Institution Press, 1985 Grant, S & Vidler, C, Economics in Context, Illustrated edition, Heinemann, 2000 Gros, D & Alcidi, C, The Crisis and the Real Economy, Intereconomics 2010, EBSCO data base Katz , R, Japanese Phoenix: the long road to economic revival, Illustrated edition, M.E. Sharpe, 2003 Lincoln, EJ, Japan, facing economic maturity, Brookings Institution Press, 1988 McConnell, CR & Brue, SL, Economics, Principles, Problems and Policies, Sixteenth Edition, The McGraw Hill Companies, 2004 Samuelson, PA, Economics, Tata McGraw-Hill Education, 1980 Sloman, Economics for Business, Pearson Education India, 2004 Read More