Causes of Economic Growth
1. Increase in AD
In the short term, economic growth is caused by an increase in AD. If there is spare capacity in the economy then an increase in AD will cause a higher level of Real GDP.
AD can increase for the following reasons.
a) Lower interest rates – this reduces the cost of borrowing and so encourages spending and investment
b) Increased wages. This ncreases disposable income and encourages consumer spending
c) Increased Govt spending. G is a component of AD
Note: Classical Economists argue that an increase in AD will only increase Real GDP in the short term. They argue that the LRAS is inelastic therefore higher AD only causes inflation.
(note: this is disputed by Keynesians. They believe the LRAS can be elastic, e.g. in a recession)
2. Long Term Economic Growth.
This requires an increase in the Long Run Aggreate Supply as well as AD.
Diagram showing Long Term Economic Growth
LRAS or potential growth can increase for the following reasons
1. Increased Capital e.g. investment in new factories or investment in infrastructure such as roads and telephones.
2. Increase in working population
3. Increase in Labour productivity, through better education and training
4. Discovering new raw material
5. Technological improvements to improve the productivity of Capital and labour e.g. Microcomputers and the internet have both contributed to increased economic growth.
See also: Causes of Economic Growth in UK
Essays and Revision Notes on Economic Growth
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