What is a Compound Growth Rate?

The components of economic growth include: 

• Physical Capital
• Human Capital
• Technology

Physical Capital

The category of physical capital includes the plant and equipment that firms use as well as things like roads (also called infrastructure). Again, greater physical capital implies more output. Physical capital can affect productivity in two ways: 

(1) an increase in the quantity of physical capital (for example, more computers of the same quality); and

(2) an increase in the quality of physical capital (same number of computers but the computers are faster, and so on). 

Human Capital

Human capital refers to the skills and knowledge that make workers productive. Human capital and physical capital accumulation are similar: In both cases, investment now pays off in higher productivity in the future.

Technology

The category of technology is the “joker in the deck.” Earlier we described it as the combination of invention and innovation. When most people think of new technology, the invention of new products like the laser, the smartphone, or some new wonder drug come to mind. In food production, developing more drought-resistant seeds is another example of technology. 

Technology, as economists use the term, however, includes still more. It includes new ways of organizing work, like the invention of the assembly line, new methods for ensuring better quality of output in factories, and innovative institutions that facilitate the process of converting inputs into output. In short, technology comprises all the advances that make the existing machines and other inputs produce more, and at higher quality, as well as altogether new products.

It may not make sense to compare the GDPs of China and say, Benin, simply because of the great difference in population size. To understand economic growth, which is really concerned with the growth in living standards of an average person, it is often useful to focus on GDP per capita. Using GDP per capita also makes it easier to compare countries with smaller numbers of people with countries that have larger populations.

To obtain a per capita production function, divide each input by the population. This creates a second aggregate production function where the output is GDP per capita (that is, GDP divided by population). 

The inputs are the average level of human capital per person, the average level of physical capital per person, and the level of technology per person. The result of having population in the denominator is mathematically appealing. Increases in population lower per capita income. However, increasing population is important for the average person only if the rate of income growth exceeds population growth. A more important reason for constructing a per capita production function is to understand the contribution of human and physical capital.

Related Topics

• Rule of Law relate to Economic Growth
• Labor Productivity
• Productivity and Learning Curve
• Experience Curve
• Acceleration Principle
• Aggregate Production Function
• How to Measure Productivity
• What is the Effect of Sustained Economic Growth?
• How are compound growth rates and compound interest rates related?
• Compound Growth Rate
• Solow Growth Model
• What are the Components of Economic Growth?
• Porter’s Diamond
• Physical Capital
• Human Capital
• Infrastructure
• Staple Thesis
• Resource Curse
• Capital Deepening
• What are Growth Accounting Studies?
• What is a Healthy Climate for Economic Growth?
• Economic Convergence
• Emerging Market Economy
• BRIC Countries 
• Growth Consensus
• Economic Conditions
• Leading Economic Indicators
• KOF Economic Barometer
• CEO Confidence Survey
• NAB Business Confidence Index