The rule of 70, and long run economic growth -, Learning Economics... Solved!


The rule of 70, and long run economic growth

Long-run economic growth:  The process by how productivity rises and thus increases the real average standard of living.

For example, using 2005 as the base year (for prices) real GDP per capita in the United States has increased from about $5,500 in 1900 to about $44,000 in 2008.  This means that the average person in 2008 could buy almost 9 times as many things (goods and services) as the average person could in 1900.

Measuring real GDP vs. potential GDP.  Because real GDP can fluctuate with business cycles,
economists like to measure the growth of potential GDP because it gives a more long run perspective.  Potential GDP also shows the actual growth in labor, capital and technology, where real GDP shows only how these factors are being used, and potentially at what capacity production is taking place at.

How to calculate growth rates:
(New GDP – Old GDP)/Old GDP

We can also calculate average GDP growth by adding up the individual growth rates, and then dividing by the number of growth rates we are adding up.  So if GDP were to grow 3%, then 2.5%, then 1.5% and finally 0.7%, we could calculate the average by adding these up then dividing by 4:
(3+2.5+1.5+0.7)/4 = 1.925

It is also interesting to know the mathematical trick called the rule of 70.  This rule allows us to easily figure out the number of years it would take to double our income (or GDP) at a given interest rate (or rate of growth). 

Number of years to double = 70/rate (either growth or interest).

For example, if we had a 3% growth rate, then 70/3 = 23.33 years.  So at a 3% growth rate it would take 23.33 years for our economy to double in size.  But if the growth rate were 10%, then 70/10 = 7 years.  So at a 10% growth rate, it would only take 7 years for our economy to double in size.  Finally let’s consider a growth rate of 4%, 70/4 = 17.5 years.  By improving growth from 4% from 3% we shave almost 6 years off of the time it takes for our economy to double in size!  The rule of 70 shows us how important even a small change in the growth rate can be.