Growth accounting

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Growth accounting is a set of theories used in economics to explain economic growth.

The total national income in an economy may be modelled as being explained by various factors. A basic function of these factors is known as the Production Function: Q = A L ^x K ^y

• K: the total stock of capital (for example, buildings and machinery) available.
• L: the size of the labor force
• A: Known as the technology available, for example inventions, production and management techniques

Here, an increase in national income must be explained by an increase in the capital available (K), an increase in the labour force (L), or an improvement in the technology used (A). The Production Function shows there are two factors involved in economic growth: Factor accumulation and improvements in efficiency.

The levels of national income, the capital stock, and the size of the labour force can all be estimated through widely available economic statistics. A mathematical model, such as the production function, can then be constructed to explain the level of national income in terms of labour, capital and a residual. A change in the residual, total factor productivity, represents the change in national income that is not explained by changes in the level of inputs (capital and labor) used. Total Factor Productivity can be measured by A=Q/(L^x K^y)

This is normally taken as a measure of the level of technology employed. The annualized growth rate of A and is called the "Solow residual." Over longer periods of time, it may be used as a measure of technological change. Over shorter periods of time, it could reflect the effect of the business cycle.