Let's begin by discussing why we measure GDP. We know that if real GDP rises from one year to the next, we can feel confident that the economy is more productive than the year before, or growing.
If GDP falls, it is an indication that the economy is slowing.
Remember, real GDP or RGDP, is gross domestic product adjusted for inflation. It shows real growth between periods, holding price levels constant.
Economic growth is defined as the measure of the change in real GDP, then, over periods of time. It is a percentage change in the value of the sum of all goods and services produced in a country's natural borders over a specified time interval.
Now, there are many ways that an economy can produce more. However, producing or consuming more does not necessarily equate to long term economic growth, which is important to keep in mind throughout this tutorial.
First, though, we need to distinguish between the short-run aggregate supply curve and the long run aggregate supply curve.
In review, this is the short-run aggregate supply curve, which can vary in the long run with the price level.
In the short run, businesses can produce more as prices go up because they will not have to pay their workers more immediately as prices are rising and they can use their existing inventories.
This is why it is possible for aggregate supply to slope upwards in the short run.
EXAMPLESuppose you pull an all-nighter to study for an exam. If you stay up all night, you can likely accomplish more than you usually would be able to do in 24 hours. However, this level of activity would not be sustainable for night after night, or indefinitely.
Long run aggregate supply, or LRAS, then, is assumed to be constant in the long run since resources are assumed to be used optimally, leaving no potential for increasing capacity.
The long-run aggregate supply curve is a vertical line, and it shows our economy's full potential in terms of production, given today's current resources.
It is the amount of production possible when resources are fully employed and there is zero cyclical unemployment.
So, our production capacity is essentially fixed unless something changes to increase our ability to produce more.
Ramping up our production in the short run can only get us so far because, again, we have limited resources like materials and workers.
So, the amount of production that producers can sustain is fixed, which is the essence of the concept of sustainability. It is the ability to utilize resources in the current timeframe without sacrificing the opportunity for future use and without disturbance to the ecosystem.
EXAMPLEIf many producers use our resources like timber faster than these resources are being replaced, this rate of growth is unsustainable.
One way is if we find more land, labor or capital:
These changes would shift our long-run aggregate supply curve, giving us the ability to produce more into the long run.
Now let's look at sustainable versus unsustainable economic growth by comparing two examples.
|Example||Use of computers||Tax breaks/stimulus programs|
|Effect||Businesses can hire the same (if not fewer) workers today and accomplish much more in less time||Expansionary policies temporarily encourage more consuming or producing|
|Economic Impact||Shifts long-run aggregate supply||Shifts aggregate demand or short-run aggregate supply; no impact on LRAS|
Now, if we are in a recession, as shown on this graph, these policies actually may be sustainable, because we are not at our full potential and they encourage the use of currently unutilized resources.
They can also help the economy get to full employment.
Unfortunately, economists debate on the exact location of the long run aggregate supply curve, though.
So, if we were already at equilibrium, as shown below, and we continued to stimulate aggregate demand through expansionary policies, anytime we push the short run equilibrium output beyond the potential long-run output, it is unsustainable.
It will cause prices to go up, and then aggregate supply will shift to the left again. This is why the long run aggregate supply curve is where it is, because it represents our potential today, given the resources that we have.
If we are already at full employment, enacting those expansionary policies are not going to cause long term economic growth that is sustainable. It will merely increase output in the short term.
The debate over sustainability can lead to some difficult decisions. Let's walk through an example of non-renewable sources of energy, which illustrates why there is so much debate--and no easy answer.
Now, we know that coal and oil are technically considered nonrenewable. So, why do we use them if they are not renewable?
Well, the economic answer is that the opportunity cost today of using them is lower than adopting new methods.
However, we know that will not always be the case. There will eventually come a time when it is actually more expensive to find what is left than what we get out of it.
EXAMPLEFor example, at some point, it will use more energy to find the remaining coal underneath the earth's surface than the energy we will get out of it. If we are talking about oil, it will get to the point where it will cost more to extract the oil than what we can get from the well--either because it is so far beneath the earth's surface or we have to find new sources of it.
Some argue that we should stop relying on these unsustainable energy sources knowing that eventually, we will need to change.
However, switching now would still be more expensive and would cause prices to rise. Therefore, while it would be good for future generations, for our children, to do this sooner rather than later, it would be bad for older individuals today, who are living on fixed incomes.
It is impossible to say absolutely what is right because the costs and benefits vary for different groups of people. We can, though, look at these costs and benefits and have discussions about various policies.
Source: Adapted from Sophia instructor Kate Eskra.