Economic growth is an increase in a country’s ability to produce more goods and services. This capacity is based on an economy’s physical capital, labor force, natural resources, and technology. Policies that encourage the accumulation of any of these lead to economic growth. Economic growth is characterized by a shift out of either the production possibilities curve or long-run aggregate supply curve (often called potential GDP).
Increasing the labor force and increasing human productivity are two important sources of economic growth. The former comes from increasing the number of people available to work and is driven by native population growth, immigration, and business investment. The latter is driven by technological progress and relates to the improvements in labor efficiency that can be achieved through more efficient use of existing physical capital.
In addition to technological progress, increased savings and investments in real assets also contribute to economic growth. Better resource allocation, economies of scale, and reduced trade barriers all help to improve productivity. Economic growth is often accelerated by a “catch-up” effect following a recession, when demand for products and services rapidly rises after businesses have more fully restored their productive capacity. The resumption of growth usually occurs as the economy’s capacity utilization rate returns to normal levels and employment growth accelerates. The faster the economy grows, the more quickly it is likely to reach its maximum sustainable level of output. This point is referred to as the peak.