Why Bigger Isn't Always Better: The Story of Economic Growth

Why Bigger Isn't Always Better: The Story of Economic Growth

Imagine this: you're running a lemonade stand. Last summer, you sold 100 glasses. This summer, you manage 120 glasses. Boom! You've experienced economic growth (and hopefully avoided sticky hands and bees). That’s the basic idea behind one of the most important concepts in IB Economics: economic growth. But unlike our lemonade empire, real-world economies are a tad more complicated.

What Is Economic Growth, Really?

Economic growth means an increase in a country’s real GDP over time. We focus on real GDP because it adjusts for inflation. Nominal GDP might say we’re richer, but if prices have gone up, we might not actually be better off. Real GDP gives us a clearer picture.

Growth happens when a country produces more stuff - thanks to better tools, more workers, or cleverer ways of doing things (like a robot that pours lemonade). These days productivity is key for any significant economic growth.

Two Types of Growth: Actual vs Potential

Imagine you're playing football on a half-sized pitch. You could still score goals, but you’re not using the full field. That's actual growth - using more of what you already have. When you open up the whole pitch (say, by adding more players or upgrading your stadium), you’re looking at potential growth.

• Actual growth: The economy moves from operating below capacity to using more of its existing resources.

• Potential growth: The economy expands its full capacity - often shown as an outward shift in the PPC or LRAS.

Real-life example? Post-COVID recovery in countries like India or Brazil represents actual growth. Investments in AI and automation in South Korea reflect potential growth.

Long-term growth is demonstrated by an outwards shift of the economy’s PPC from PPC1 to PPC2 or from point X to point Y. This can be caused by improvements in the quantity and/or quality of factors of production.

Long-term Economic Growth can also be shown using the AD-AS Model

An increase in potential growth is shown by an outwards shift of the long run aggregate supply (LRAS curve).

For example, an increase in the labour supply or technology development will shift the LRAS curve outwards, ceteris paribus. This causes real GDP to increase from YF1 to YF2 and the average price level to fall from PL1 to PL2 which helps to reduce the general cost of living.

The GDP Equation – C + I + G + (X-M)

Yes, it looks like algebra, but it's just:

• C: Consumption

• I: Investment

• G: Government spending

• X-M: Exports minus imports (net exports)

A rise in any of these pushes AD to the right. That’s the economy saying, “Let’s grow!”

Calculating Growth: Mind the Inflation

Say your country’s GDP jumps by 6%. If inflation is 4%, then your real GDP increase is only about 2%. The GDP deflator helps with this maths:

Real GDP = (Nominal GDP / GDP deflator) x 100

Why Governments Love Growth

When economies grow:

• More jobs are created

• Wages rise (sometimes)

• Tax revenue increases

• Public services improve

Example: Germany’s long-term economic growth helped fund its world-class healthcare and education systems.

But Wait – Growth Has a Dark Side

1. Environmental Damage

More factories = more emissions. More cars = more traffic. Economic growth can strain ecosystems (ask the Amazon rainforest).

2. Inequality

Not everyone gets a big slice. In the US, top earners have seen incomes soar while others barely notice a difference.

3. Inflation Risk

Too much demand = rising prices. If AD increases too fast, the price level shoots up, reducing the purchasing power of money.

4. Demerit Goods

Higher incomes sometimes mean higher spending on things like alcohol, gambling, or fast food, which can harm social welfare.

Final Thought: It’s Not Just About More

Growth matters. But smart growth matters more. Economists and policymakers must juggle progress with sustainability and equity. A country with massive GDP growth but extreme inequality and environmental degradation isn’t exactly winning.

As always in IB Economics: evaluate, don’t just describe. More output is great, but ask: who benefits, at what cost, and is it sustainable?

Stay well