Economic Growth

Supply Factors and Economic Growth

Any factor that causes an increase in aggregate supply may lead to an increase in Australia’s rate of growth in GDP. As such, we can use the model of supply and demand to help us assess the impact of a change in any aggregate supply factor.

We can see above that a shift in the supply curve to the right will cause the equilibrium point to move to the right. As a result, it is possible that this will lead to growth in the Australian economy. Once again we will consider an example.

In theory, productivity improvements should lead to higher rates of growth for the Australian economy. Productivity refers to our ability to produce a certain amount of output from a given number of inputs. If we increase our output from the same number of inputs, or if we require fewer inputs to make the same amount of output, then we say that our productivity has improved.

Productivity is closely associated with efficiency. And as we become more efficient the impact on aggregate supply is apparent – we will be able to use our productive resources to produce more, and the effective impact is a lower cost per unit for any good or service that is produced. Therefore, the aggregate supply curve will shift to the right and the Australian economy may experience growth.

During the last ten years productivity has been a major focus of the Australian government. As a result, we have seen several years of excellent productivity gains, as can be seen in the graph below.

Economic growth and labour productivity in Australia

The theoretical link which has already been described becomes apparent from this graph. During a period of strong productivity gains (such as the period 1996/7 through to 1998/9) our growth rate was able to improve – peaking at 5.2% in 1998/9. Similarly, as productivity gains were lower in 1999/2000 we experienced a much slower rate of growth, falling to an increase of only 1.0% in the following year.

In 2004/5, labour actually became less efficient. It is not surprising, therefore, that this coincided with a fall in the rate of growth. Many commentators have stated that unless certain supply side reforms are implemented to address this problem, lower rates of growth may become in the norm in the near future.

Of course it is also true that there are times when the link is not apparent. For example, in 2005/06 we experienced an improvement in productivity and yet at the same time the rate of economic growth fell to 2.6%. How can this be? It is important to remember that while we have established a theoretical link between productivity gains and growth, this is only one of many factors acting on the economy at any one time. As a result, although productivity gains were improving in that year, the many other factors acting on the economy at the time (for example, increasing interest rates, a high dollar and a large budget surplus) combined to produce the outcome for growth that is observed.

As you continue your study of Economics it is vital that you remember that there will always be many factors acting on the economic goals that we have, and as such a change in any one factor may not have the impact that a theoretical link may suggest.

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