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The power of sustained economic growth

Nothing is more important for people’s standard of living than sustained economic growth. Even small changes in the rate of growth, when sustained and compounded over long periods of time, make an enormous difference in the standard of living. Consider [link] , in which the rows of the table show several different rates of growth in GDP per capita and the columns show different periods of time. Assume for simplicity that an economy starts with a GDP per capita of 100. The table then applies the following formula to calculate what GDP will be at the given growth rate in the future:

GDP at starting date × (1 + growth rate of GDP) years  = GDP at end date

For example, an economy that starts with a GDP of 100 and grows at 3% per year will reach a GDP of 209 after 25 years; that is, 100 (1.03) 25 = 209.

The slowest rate of GDP per capita growth in the table, just 1% per year, is similar to what the United States experienced during its weakest years of productivity growth. The second highest rate, 3% per year, is close to what the U.S. economy experienced during the strong economy of the late 1990s and into the 2000s. Higher rates of per capita growth, such as 5% or 8% per year, represent the experience of rapid growth in economies like Japan, Korea, and China.

[link] shows that even a few percentage points of difference in economic growth rates will have a profound effect if sustained and compounded over time. For example, an economy growing at a 1% annual rate over 50 years will see its GDP per capita rise by a total of 64%, from 100 to 164 in this example. However, a country growing at a 5% annual rate will see (almost) the same amount of growth—from 100 to 163—over just 10 years. Rapid rates of economic growth can bring profound transformation. (See the following Clear It Up feature on the relationship between compound growth rates and compound interest rates.) If the rate of growth is 8%, young adults starting at age 20 will see the average standard of living in their country more than double by the time they reach age 30, and grow nearly sevenfold by the time they reach age 45.

Growth of gdp over different time horizons
Growth Rate Value of an original 100 in 10 Years Value of an original 100 in 25 Years Value of an original 100 in 50 Years
1% 110 128 164
3% 134 209 438
5% 163 338 1,147
8% 216 685 4,690

How are compound growth rates and compound interest rates related?

The formula for growth rates of GDP over different periods of time, as shown in [link] , is exactly the same as the formula for how a given amount of financial savings grows at a certain interest rate over time, as presented in Choice in a World of Scarcity . Both formulas have the same ingredients:

  • an original starting amount, in one case GDP and in the other case an amount of financial saving;
  • a percentage increase over time, in one case the growth rate of GDP and in the other case an interest rate;
  • and an amount of time over which this effect happens.

Recall that compound interest is interest that is earned on past interest. It causes the total amount of financial savings to grow dramatically over time. Similarly, compound rates of economic growth, or the compound growth rate    , means that the rate of growth is being multiplied by a base that includes past GDP growth, with dramatic effects over time.

For example, in 2013, the World Fact Book, produced by the Central Intelligence Agency, reported that South Korea had a GDP of $1.67 trillion with a growth rate of 2.8%. We can estimate that at that growth rate, South Korea’s GDP will be $1.92 trillion in five years. If we apply the growth rate to each year’s ending GDP for the next five years, we will calculate that at the end of year one, GDP is $1.72 trillion. In year two, we start with the end-of-year one value of $1.67 and increase it by 2%. Year three starts with the end-of-year two GDP, and we increase it by 2% and so on, as depicted in the [link] .

Year Starting GDP Growth Rate 2% Year-End Amount
1 $1.67 Trillion × (1+0.028) $1.72 Trillion
2 $1.72 Trillion × (1+0.028) $1.76 Trillion
3 $1.76 Trillion × (1+0.028) $1.81 Trillion
4 $1.81 Trillion × (1+0.028) $1.87 Trillion
5 $1.87 Trillion × (1+0.028) $1.92 Trillion

Another way to calculate the growth rate is to apply the following formula:

Future Value = Present Value × (1 + g) n

Where “future value” is the value of GDP five years hence, “present value” is the starting GDP amount of $1.64 trillion, “g” is the growth rate of 2%, and “n” is the number of periods for which we are calculating growth.

             Future Value = 1.67 × (1+0.028) 5  = $1.92 trillion

Key concepts and summary

Productivity, the value of what is produced per worker, or per hour worked, can be measured as the level of GDP per worker or GDP per hour. The United States experienced a productivity slowdown between 1973 and 1989. Since then, U.S. productivity has rebounded (the current global recession notwithstanding). It is not clear whether the current growth in productivity will be sustained. The rate of productivity growth is the primary determinant of an economy’s rate of long-term economic growth and higher wages. Over decades and generations, seemingly small differences of a few percentage points in the annual rate of economic growth make an enormous difference in GDP per capita. An aggregate production function specifies how certain inputs in the economy, like human capital, physical capital, and technology, lead to the output measured as GDP per capita.

Compound interest and compound growth rates behave in the same way as productivity rates. Seemingly small changes in percentage points can have big impacts on income over time.

Problems

An economy starts off with a GDP per capita of $5,000. How large will the GDP per capita be if it grows at an annual rate of 2% for 20 years? 2% for 40 years? 4% for 40 years? 6% for 40 years?

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An economy starts off with a GDP per capita of 12,000 euros. How large will the GDP per capita be if it grows at an annual rate of 3% for 10 years? 3% for 30 years? 6% for 30 years?

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Say that the average worker in Canada has a productivity level of $30 per hour while the average worker in the United Kingdom has a productivity level of $25 per hour (both measured in U.S. dollars). Over the next five years, say that worker productivity in Canada grows at 1% per year while worker productivity in the UK grows 3% per year. After five years, who will have the higher productivity level, and by how much?

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Say that the average worker in the U.S. economy is eight times as productive as an average worker in Mexico. If the productivity of U.S. workers grows at 2% for 25 years and the productivity of Mexico’s workers grows at 6% for 25 years, which country will have higher worker productivity at that point?

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Questions & Answers

can I get simple language and examples?
Gajendra Reply
what is demand
Yavara Reply
what is fiscal policy
David
fiscal policy can be defined as the use of government's income and expenditure for a specific purpose
Nzenwata
ahhhh.. i dont what is expindetures
ian
It is the policy use by govt to influence economy ( manage inflation and deflation). Steps involved are govt spending and taxation.
Tactful
Demand is quantity of good a person is willing and ready to buy at given period of time at given price.
Tactful
good
abubakar
good but high language
Gajendra
lower the language @gajendra Singh
abubakar
Explain economic growth with the use of ppf?
Michael Reply
what z the meaning of ppf
rivan
do u mean ppc
Nzenwata
Yes pls ppc
Michael
an expansionary fiscal policy could be achieved by what
David
if the price of cigarettes ,food and alcohol rised by 10% in a year ,which is most likely to affect the cpi the most.
David
what measures would be suitable for reducing a recessionary gap.
David
increasing the level of government government expenditure is an instrument of what
David
A reductionin income tax rates would blank the blank of the multiplier
David
progressive taxes may slow down economic recovery .This is as a result of what
David
money acts as a safe guard against inflation something and something one of a function of money
David
A rise in expenditure for consumer goods something and something ,one of the cause of cost- push inflation
David
PPC IS production possibility curve. It show possible good which can be produced by an economy with given resource and technology.
Tactful
Recessionary gap can be solved by Monetary and Fiscal policy
Tactful
What are the positive effects on the economy to legalize drugs?
Richard Reply
wat factor give raise to monopoly
Ebenezer Reply
a product which is unique /it has very less substitutes in the market. so this product has no much competition .... for example , railways
mikey
its a monopoly
mikey
does monology has factors or it has merits n demerits
rivan
monopoly or oligopoly is just a type of market in which demand and supply is measured to meet public interests
mikey
economy is all about psychological behaviour of humans to each other and to environment economists role is to keep everything in equilibrium
mikey
factors give rise to monopoly. 1. Patent right 2. Cartel 3. Govt policy. 4. Control over raw material. 5. money for investment
Tactful
oligopoly and monopoly are examples of imperfect market..
Nzenwata
please explain what is elasticity of supply
Austine Reply
is the responsiveness of quantity supplied of commodity to changes in its own price
rivan
what is the cause of a country's population
Destiny Reply
please it seems your question is not clear ,is it the cause of increase or decrease population in a country or what
okai
what is producer surplus
Destiny Reply
is the excess earns btn wat a producer was willing to charge for e commodity and wat actually receives after selling it
rivan
OK good
Destiny
yeap
Bright
what is supply curve
Destiny Reply
are curve that do not obey the law of supply eg aren't +ve
rivan
half of 1%
Destiny
as in what do u mean by that
rivan
it simply shows the quantity of goods that a film is willing to supply at each price of a commodity
Destiny
OK what is the law of supply as u said
Destiny
It is the indifference curve that indicates the aggregate responsiveness of supply to the price of a commodity, and sometimes its demand of that same commodity.
Gh
nice
Destiny
pls explain how indifference curve connects to the aggregate responsiveness of supply to the price of a commodity
JOSHUA
law of supply according to me states that wen thea z higher price of commodity, the higher will be the supply and lower the supply will be for a commodity other factors remain constant
rivan
Joshua be clear to your QN plizzz
rivan
pls read Gh's comment and break down for me
JOSHUA
may be he can explain more because am am also not getting what he was meaning in that statement
rivan
plizzz GH explain to us
rivan
When demand and supply intersection
Pronoy
then it z called what
rivan
can I learning what is meaning off economics
Jimcaale
can you tall me what is meaning
Jimcaale
good
abubakar
please oligopoly explan.......
Zahid
in oligopoly there is a competition between companies, becoz all those companies produce almost similar products in monopoly , product has no substitutes in the market for competition, so people have no choice to choose another similar product over this, becoz there is no similar product
mikey
oligopoly : mobile phone manufacturing companies have huge competition over one another
mikey
what is consumers surplus
Destiny Reply
is a difference btn consumers planned expenditure and actual experience on the commodity
rivan
OK good
Destiny
What exactly are factors that affects Demand and Supply?
Chandrapaul Reply
demand factors price o commodity size o population level o advertising season 4 commodity testes and preferences price o other related commodity level o consumers income government policy on taxation
rivan
supply factors general price level natural factor level o taxation technology political climate cost o production number o producers aggregate demand working conditions
rivan
yea___ Demographical psychographical geographical factors also account for determination of demand and supply
Gh
definition of economics
Emmanuel Reply
economics means to manage the limited resources one has in order to maximize satisfaction.
sekou
Economic is a science which study of human behavior as a relationship between and scare means which have alternative uses"
Jacob
phycology of world
mikey
what is price elasticity of supply
Destiny Reply
What is the law of demand and supply
Destiny
This is when there is a greater percentage change in the supply of commodities as per the percentage change in price. More producers tend to supply more when there is a higher change in the price of commodities and vice versa when price drops.
Gh
this seems to explain making decisions on the margins very clearly
JOSHUA Reply
what are the importance of studying Economics ?
Amoako Reply
Economization
Zeleman
to relate economic principles to the problems o development. exposes students to e future. acquire knowledge. etc ....
rivan
it teaches how to make choice and decisions in our homes and every across the nation
Destiny
what is price elasticity of supply
Destiny
five definition of economic s
Emmanuel
economics help to look at the behavior of financial market
okai
our choices work along side with with... limited resources
Nzenwata
economic help d government in d allocation of resources
Nzenwata
am lost abt that last statement
rivan
It helps us to understand how the economy works.
okai
factors of monopoly
Ebenezer
economics helps in the allocation of scarce resources
jasmine
equitable distribution of wealth
Nzenwata

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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