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There is one important distinction to be made. When an economy is generating with excess capacity, GDP may be increased by putting the unemployed resources to work. The problem of economic growth is how to increase output when all resources are fully employed, therefore to an increase in the country's productive potential. This means, on that economic growth can only be measured between periods in the utilization of resources or rates of unemployment.
According to the graph above, it is a phases of the business cycle, but we can find that, its content two lines. One is curve line, another one is straight line. The curve line represents the real GDP. This means it is a real capacity and what is happening now. But, the straight line represents the potential GDP. This means it is the best capacity. In the other word, its means the output produced when the economy is operating at its nature rate of unemployment.
The most important thing is, only GDP can affect the economic growth. GDP is the total market value of all the final goods and services produced within an economy in a given year. On the other hands, factor that affect GDP of an economy is depends on labour, capital, technology, natural resources, skill, education, economics of scale, reallocation of resources.
Labour is the main element in a company. If a company hires a good quality of labour, the productivity should be raise. Besides, the size of the working population is related to the age structure of the population; thus an increase in the quantity of labour available will normally occur as move people move in to the working age group. This will emerge into slowly. Example the country like United Kingdom will change the quality of labour to increase production.
Changes in capital can contribute to economic growth in two ways. First, an operator may purchase an extra van to those he is already using; employ an additional driver to increase output. It is known as capital widening. Second, the operator may change his existing van for the same number of larger vehicles to increasing output again. This is called capital deepening.
Changes in technology will also lead to economic growth. When a company input a new technology in the factory, the production should be increases, because the more efficient system in process a goods.
The economy may benefit when discovery and development of unknown natural resources (until today). Example like North Sea oil. It is existence offers an important source of growth.
Increased skills and education in a person is described as investment in people. This is because; people have an important part to play in raising the productivity of labour force.
In economies of scale, it consists of internal economic. In internal economic has some factor like buying economic. It means, a huge buying of a material and discount are given. So, the cost of production will be reducing. Therefore, there is extra money to produce more products in the market.
Reallocation of resources means when economic development takes place, there is a tendency for labour to shift from primary (agriculture) to secondary production (manufacturing) and later to the service industries. For example, in Japan, since the Second World War, there has been a movement of labour from agriculture to manufacturing; there have also been very high growth rates until 1990s.
Although GDP is only one of the factor that affect economic growth, but government policy can control the rate of GDP, either increase or decrease the GDP. Government policy in economic analysis is concerned with the means of achieving particular economic objectives. The choice of the objectives is depends on how people want economic resources to be used in order to satisfy their wants. While government will use some policy to control the GDP which are fiscal policy, government budget policy and money policy.
In fiscal policy, it is the deliberate manipulation of government income and expenditure so as to influence the country's spending, employment and price level. The objectives of fiscal policy are securing efficient allocation of economic resources, maintaining the full employment, acceleration the rate of economic growth, and also controlling the equitable distribution of income and wealth. This objectives can be achieved when no any fluctuation in the business cycle or free of inflationary and deflationary gaps.
AEWhen the economy is in recession phases, this means, the full-employment income is more than equilibrium income. So, the government will used expansionary fiscal policy to bring the economy out of the recession.
In the graph above, it is facing the deflationary gap, so, the government will increase the spending or reduce the tax or doing both of them. Refer to budget deficit policy; the government spending is more than revenue, so, the government will sell the government's bonds through internal borrowing to domestic financial market like Sukuk, and through also external borrowing to sell the bonds to foreign financial market. The purpose of government's action is wants to bring the economy out of the recession.
In the graph above, it is facing the inflationary gap, this means, the government will decrease the government spending or increase the taxes or both of them. Refers to the budget surplus policy, the government spending is less than its revenue. In this case, the aim of government's action is wants to bring the economy out of the inflation.
But, the balanced budget policy is different, it is the policy that all the government's spending equal to the revenue receive. That means the economy is free of the any inflation or recession.
In monetary policy, it is the policy that changes interest rates and the amount of money in the economy under the control of the Central Bank. The principal aim of the monetary policy is to keep inflation in control. When the economy is in recession, the expansionary monetary policy will be used to increase the money supply. The Central Bank might lower the interest rate and inject it into economy to control the recession. When the economy is in inflation, the contractionary monetary policy will be used to decrease the money supply. The Central Bank might also increase interest rates to slow real GDP growth and prevent inflation increasing.
In the graph (example) above, we can see different GDP in different year. Economic growth is good or not is depends on the increasing of quantity or price of a substance. In the case above, although the GDP was increased, but the reason of increased was increasing in the price. In this case, it is no good because it is inflation. If the GDP increase is because of the increasing in quantity, then the economic growth consider is good.
There are also some advantages and disadvantages in economic growth. First advantage of economic growth is improvement in living standard. This means, the rate of poverty will reduce. Second, it will raise the rate of employment. So, more and more people will get a job. Third, it will increase in capital investment. It will raise aggregate demand and output and encourages other people to invest. Forth, it will create a business confident to businessman. Fifth, it will increase the potential in environment benefit. This means, when the country becomes richer, the government will invest more money in cleaner technologies, so, the environment will be protected.
On the other hands, the first disadvantage of economic growth is we must face the inflation risk. This means, all the good' price will be increase, and it will affect the low income family. Second, it will also affect the environment. This is because; the fast growth of production and consumption will increase the noise, air pollution and also the road congestion. Third, it will occur inequality of income and wealth. Not all the benefits of growth are distributed evenly. We can see a rise in real GDP but also growing income and wealth inequality in society which is reflected in an increase in relative poverty. For example, the African and South American countries, they have a big gulf between richest and poorest people. Forth, it wills also happening the different regional. Although the living standard is rising, the gap between rich and poor people will still exist. So, in their mind thinking, they are different kind of people.
G F Stanlake & S J Grant 1995, Introduction Economics, 6th edn, Longman, Singapore.