Essential definitions

Economic growth

An increase in real GDP over time.

Actual growth

An increase in the economy’s current real output.

Potential growth

An increase in the economy’s sustainable productive capacity.

Produce more with existing resources

Economic growth is an increase in real GDP. Real values remove price changes, so higher prices alone do not count as growth. The growth rate is (new real GDP − old real GDP) ÷ old real GDP × 100. Use the same price base and currency units for both periods. The result is a percentage over the stated period.

Suppose spending recovers while a factory has idle machines. Higher sales encourage it to restart machines and hire workers. Output rises even though its equipment and technology have not changed. This is actual growth through fuller use of existing capacity. It can reduce unemployment, but becomes harder once spare capacity is exhausted.

Increase the ability to produce

Potential growth increases sustainable capacity. New equipment, additional productive workers, better skills and improved technology allow more output without relying on unusually intensive resource use. Investment adds to spending today and can add to capacity once the equipment is operating.

A PPC diagram puts quantities of two goods on its axes. Moving from inside the frontier towards it uses existing capacity better; shifting the frontier out increases capacity. The AD–AS diagrams instead use real GDP horizontally and the price level vertically. A rightward AD shift can raise actual output, while a rightward LRAS shift raises potential output. Label each mechanism separately.

Compare actual and potential growth

If actual real GDP rises from 240 to 252 billion, it grows 5%. If potential rises from 260 to 265.2 billion, capacity grows 2%. Actual output grows faster in this example because previously idle resources are used more fully, yet output remains below potential.

Capacity growth alone does not ensure customers buy more. Conversely, years of weak sales can discourage investment and damage future capacity. For living standards, also allow for population: growing total output need not mean growing output per person. Growth compounds over time because each year's increase builds on the preceding year's level.

Apply and evaluate

• Investment can support both current AD and future supply, but the capacity effect depends on productive project selection.
• Growth based only on increasingly intensive resource use is harder to sustain once spare capacity is exhausted.

Real-world application