MEASURING ECONOMIC GROWTH

Unprecedented government involvement in the national economy during the Great Depression (1930s) and World War II (1941–1945) marked the end of laissez-faire capitalism in the United States. Just one year after the close of World War II, Congress passed the historic Employment Act of 1946, an act that established three main macroeconomic goals for the U.S. economy—full employment, economic growth, and price stability.

Economic Growth Defined

Economic growth occurs when a country's real gross domestic product (GDP) increases over time. Perspectives on economic growth have shifted in recent years, however. Some economists believe that economic growth occurs only when national output increases per person, as measured by real GDP per capita. Others view economic growth qualitatively as well as quantitatively and insist that rising real GDP per capita be accompanied by measurable improvements in people's quality of life.

One way to illustrate economic growth is by an outward, or positive, shift in a nation's production possibilities frontier (PPF). Such a shift is shown in Figure 8.2. The positive

Figure 8.2 Economic Growth: Expanding Society's Production Possibilities

shift of the country's PPF from curve AB to curve CD in Figure 8.2 indicates that more consumption goods and investment goods are produced along the outer curve CD than along the original inner curve AB. The positive shift of the country's PPF is the result positive economic or political forces that affect the supply side of markets. That is, these forces enable an economy to produce more goods and services than was originally possible. Important determinants of economic growth, such as expanded national savings and investment and the efficient use of resources, are discussed in the next section of this chapter.

Tracking Economic Growth with the Business Cycle

The business cycle illustrates the short-term ups and downs in the real gross domestic product (GDP) over time. The business cycle is comprised of two phases, an expansion and a contraction, as shown in Figure 8.3. During an expansion the real GDP rises. Improvements in job creation, business investment, real income, consumer confidence, and consumer spending often accompany expansions. During a contraction the real GDP falls. A contraction of at least two consecutive quarters, or six months, is normally considered a recession. Today economists at the National Bureau of Economic Research (NBER) consider a variety of other factors before they declare that the U.S. economy is in recession, however. Other benchmarks of a recession are negative changes in the unemployment rate, investment levels, incomes, and retail sales figures. A depression is a severe, prolonged recession.

The business cycle also has two points: a peak and a trough. The peak represents the highest point on a business cycle, while the trough is the lowest point. These points are also

Figure 8.3 The Business Cycle Model

shown in Figure 8.3. Technically, an expansion in the business cycle occurs between the trough and the peak. A contraction, on the other hand, occurs between the peak and the trough.^[1] Business cycles illustrate short-term changes in national output. But a series of business cycles can also illustrate long-term growth trends over 20, 50, or even 100 years.

Economists use three types of economic indicators to predict and assess the duration of business cycles in the U.S. economy. The leading economic indicators are indicators that predict the direction of a business cycle. Leading economic indicators might signal an expansion or a contraction. Leading indicators that point to an expansion include increases in business start-ups, applications for building permits, the average manufacturing workweek, new orders for producer and consumer goods, and the Dow Jones Industrial Average (Dow). Declines in the leading indicators suggest the economy is headed for a contraction. Coincident economic indicators occur in conjunction with a change in the business cycle. As an economy enters an expansion, for example, personal income, sales volume, and production levels rise. Conversely, when an economy enters a contraction, personal income, sales, and production tend to decline. Lagging economic indicators occur months after a change in the business cycle has occurred and often persist even into the next phase of the business cycle. Unemployment is an example of a lagging indicator. Unemployment tends to rise during a contraction and generally carries over for a time into the next phase of the business cycle, the expansion.

Benefits of Economic Growth

Economic growth expands personal and business opportunities and choices. First, economic growth improves people's standard of living. Standard of living refers to the

Table 8.3 Real GDP and the Standard of Living, 1960–2010 (measured in constant 2005 $US)

Source: U.S. Bureau of the Census, “Table 679,” “Table 455,” Statistical Abstract of the United States: 2012 (Washington, DC: U.S. Government Printing Office), 2011, 443; Bureau of Economic Analysis, “Current Dollar and 'Real' Gross Domestic Product,” July 27, 2012.

material well-being of people. Economic growth in the United States gained momentum during the twentieth century, and people's standard of living, on average, rose accordingly. Between 1900 and 1950 people's real income—income adjusted for inflation—increased by about 170 percent.^[2] As a result, the standard of living improved for the blossoming middle class, which now could afford to buy many of the comforts of life such as a home, a car, consumer durables, and other consumer goods. Similarly, between 1960 and 2010 Americans' real per capita disposable (after-tax) income tripled, as did their spending on consumer items, as shown in Table 8.3.^[3]

A second benefit of economic growth is an improved quality of life for people. Quality of life implies a higher standard of living plus other improvements in the human condition. Economic growth helps create the wealth necessary for public investments in education, health care, infrastructure, social programs, and so on. The size of public investments in these programs is dependent on the amount of tax revenues collected from society's private sector, however. The richer advanced economies make significant public investments, which increase people's economic opportunities, expand their choices, and attend to their needs. The wealth derived from economic growth also enables people to enjoy additional leisure pursuits such as personal interests and recreation.

A third benefit of economic growth is its ability to maintain the virtuous cycle of growth and development. Growing, prosperous societies are able to save money, a prerequisite for investments in new technology, private and social capital, human capital, and entrepreneurship. Business investment results in business formation, job creation, and technological advances. Investment is also the wellspring of product innovation, as evidenced by improvements ranging from computers and software, to cell phones and tablets, to hybrid automobiles. Meanwhile, less efficient producers and those that cannot adapt to changing tastes in the marketplace are weeded out—a process colorfully described by economist Joseph A. Schumpeter as “creative destruction.”^[4]

• [1] National Bureau of Economic Research (NBER), “The NBER’s Business Cycle Dating Committee,” September 20, 2010
• [2] U.S. Bureau of the Census, “Series D 722-727: Average Annual Earnings of Employees, 1900 to 1970,” “Series 683-688: Indexes of Employee Output (NBER), 1869 to 1969,” Statistical History of the United States: From Colonial Times to the Present (New York: Basic Books, Inc., 1976), 162, 164.
• [3] U.S. Bureau of the Census, “Table 679: Selected per Capita Income and Product Measures in Current and Chained (2005) Dollars, 1960 to 2010,” Statistical Abstract of the United States: 2011 (Washington, DC: U.S. Government Printing Office, 2012), 443; Bureau of Economic Analysis, “Current-Dollar and ‘Real’ Gross Domestic Product,” July 27, 2012
• [4] Joseph A. Schumpeter, Capitalism, Socialism, and Democracy, 3rd ed. (New York: Harper & Row Publishers, 1950), 82-83