An increase in output can be achieved in two basic ways.

The first scenario: Aggregate demand increases, so supply extends. In this way the economy is making more use of its resources, but there is still spare capacity, and productive potential hasn't increased.

The second scenario: Aggregate supply increases. National output increases without demand increasing and productive potential of the country has increased.

Now I know that the second scenario is economic growth for sure, as economic growth is generally characterised by an increase in the productive potential of country. But is the first scenario also economic growth? That is, is it called economic growth if a country just makes use of more resources already available to satisfy increased demand?

Furthermore, can the first scenario be shown on a PPC? Perhaps a shift from a point within the curve to a point on the curve?

  • $\begingroup$ Both are economic growth, because economic growth is measured with GDP (in addition, be sure to consider the resulting inflation/GDP deflator in the case). However, only the second scenario can increase the output in the long run. So if you like to talk about the capacity then you should use the 2nd way to measure. $\endgroup$ – Dole Jan 24 '16 at 12:50

There are actually 2 types of economic growth. Actual growth is when output increases. Potential growth is when productive potential of the economy increases.

If long run aggregate supply increases without any change to short run AS, then you have potential growth but not actual growth. This might happen with if a new discovery is made, but has not yet been applied in industry.

If SRAS increase without any change to LRAS, then you have actual growth, but no potential growth. This might happen to an oil-dependent economy if there is a temporary fall in oil prices.

As long as there is short-term capacity in the economy, increases in aggregate demand will lead to actual growth. Aggregate demand, however, cannot lead to potential growth except by affecting LRAS (e.g. through changes in producer expectation etc).

Finally, you are correct in that actual growth is shown by moving a point closer to the PPC/ in the North East direction.

See any lecture material: http://www.tutor2u.net/business/strategy/economy-economic-growth.html


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