Short on time? This page is the recap. For explanations, graphs and worked examples, use the full study guide.
Recap
- Economic growth = growth in real GDP per capita. Policy can raise it by raising productivity (output per worker) or labour force participation (more of the population at work).
- Productivity rises with more physical capital, more human capital and better technology per worker.
- Public investment in infrastructure (roads, ports, power, broadband), education and research raises productivity.
- Supply-side fiscal policies use taxes, spending and benefit rules to change incentives to work, save, invest and innovate, raising aggregate supply and potential output.
- Most growth policies raise AD in the short run; their lasting effect is a rightward shift of LRAS and an outward shift of the PPC.
Key relationships
| Policy | Short run | Long run |
|---|---|---|
| Lower marginal tax rates on work | AD right (more consumption) | Participation and hours rise: SRAS and LRAS right |
| Lower taxes on saving or investment | Small AD effect | More capital per worker: LRAS right |
| Public infrastructure | AD right (G rises) | Productivity rises once in use: LRAS right |
| Funding education, training, research | AD right (G rises) | Human capital and technology rise: LRAS right |
| One-off cash payment to households | AD right | No change in capacity: LRAS unchanged |
Growth of real GDP per capita ≈ growth of productivity + growth of employed share of population.
Assumptions behind the analysis
- The model gives the direction of incentive effects, not their size.
- After a supply-side policy, real output rises, but the price level depends on the relative sizes of the AD and AS shifts.
- Growth policies take time; training and research pay off years later.
- Borrowing to pay for a policy can crowd out private investment (Topic 5.5).
Mistakes to avoid
- Calling every fiscal stimulus a growth policy. Only a rise in capacity gives lasting growth.
- Drawing a supply-side policy with AS shifts only: show the AD shift too.
- Stating that a supply-side tax cut must lower the price level.
- Measuring growth by real GDP instead of real GDP per capita.
- Forgetting the opportunity cost: more capital goods now means fewer consumer goods now.
- Shifting SRAS alone for a lasting change in capacity: LRAS must shift.
Quick self-check
VD is the valda, the currency of the fictional country Valdoria used in the study guide.
- Output per worker is VD 60,000 and 45% of the population is employed. What is real GDP per capita? (VD 27,000)
- Productivity grows 3% and the employed share of the population grows 2%. About how fast does real GDP per capita grow? (about 5%; exactly 5.06%)
- A government gives every household a one-off payment while the economy is at full employment. What happens to LRAS? (Nothing: it is a demand policy, so the long-run result is a higher price level.)
Next: practice questions.