1.4 Economic Growth

So far, we know how to measure the standard of living, how to make meaningful comparisons between countries and within a country over time. But how do we measure changes in the living standard over time? Real GDP per capita growth is the best measure of changes in economic well-being. The simplest way to measure economic growth is by taking the percentage change in real per capita GDP between two consecutive periods. If we denote real GDP per capita in year t as Y_t, then the growth in real per capita GDP, g, between any two years, t and t – 1, expressed as a decimal is given by:

From Equation (3), we can express Y_t in terms of Y_t-1 and the growth rate:

Take the natural logarithm (the logarithm to the base e), ln, of both sides of equation (4):

A useful Maclaurin expansion-based approximation is that for any small positive number, a,

Three useful properties of logarithms are the product rule, Equation (7), quotient rule, Equation (8), and power rule, Equation (9):

where b is a positive number. Applying first Equation (7) and then Equation (6) to Equation (5) yields:

Equation (10) is a useful approximation for computing growth rates that is commonly used by economists.

We use Equation (3) to compute the annual growth rate in Canada’s GDP in the third column of Table 3. We leave it as an exercise to you to compute the growth rate using the approximation in Equation (10). Notice the large variation in the growth rate of the Canadian economy from one year to another; these are transient cyclical changes. While business cycle fluctuations are a very important macroeconomic concept, our focus here is not on the short run but the long run. It is trends that drive the standard of living over time and differences in long-run growth rates determine differences in standards of living across countries.

Data source: Statistics Canada