2.5 Economic Growth Flashcards
What causes economic growth
An increase in quality or quantity of one of the four factors of production
land, labour, capital or enterprise
How will an increase in LRAS contribute to economic growth
- An increase in LRAS will increase the productive capacity of the economy along with economic growth
How does Land contribute to economic growth
The discovery of new resources e.g. oil will increase economic growth.
most potent effect in developing countries
eval: Dutch Disease
What is Dutch Disease
the problems associated with a rapid increase in the production of raw materials (like oil and gas) causing a decline in other sectors of the economy. When the raw materials run out, the economy can be in a worse position than before.
What are the effects of Dutch Disease
- **Appreciation in currency. **
- Decline in competitiveness. The problem of this appreciation in the exchange rate is that other trade-able sectors of the economy will become uncompetitive.
- **Growth in luxury imports. **
- Growth in real wages. causing another problem for manufacturing firms as they have to increase real wages to retain workers. This will further decrease the competitiveness of manufacturing exports.
- Indirect-deindustrialisation.
- Income inequality.
- Tax revenue. the government will often cut other taxes and come to rely on oil tax revenues.
How does an increase in the size of the workforce contribute to economic growth
A change in the age profile of the population i.e. the amount of people of working age will affect economic growth: the more people of working age there are, the more growth there will be.
How could the gov. increase the number of working people
- Raise the retirement age
- Provide free childcare
- Encourage immigration
How does the quality of the workforce contribute to economic growth
- Education makes workers more efficient
- Less likely to suffer structural unemployment so reduce NRU and increase LRAS
How does capital contribute to economic growth
- Sustained investment allows access to new techhnology to improve productivity
- More machines –> more goods
How does enterprise contribute to economic growth
If the government offers tax benefits and grants, they will encourage the development of business, creating jobs and meaning more goods and services are produced, which will increase economic growth
How does excessive wealth distribution affect incentives for enterpirse
If there is too much wealth distribution (i.e. too high taxes and benefits), there will be little incentive to work hard as the rich know a lot of their money will be taken away and the poor know that there is no need to work as benefits will give them just as much money as a job on minimum wage.
This lack of incentive will mean that businesses won’t invest and so there will be little to no economic growth.
What is actual growth
actual growth is the percentage change in GDP
What is percentage growth
Potential growth is the change in productive potential of the economy over time, so the LRAS or PPF curve shifts.
How does export-led growth affect LRAS
Intially increased exports affect AD but sustained high ecports force investment and increased demand for labour
What are the advantages of export-led growth
- Injection into Circular Flow causes rise in AD
- Growing GDP causes accelerator effect
- Compplementary industries benefit; Rotterdam in Netherlands
What are disadvantages of export-led growth
- Overdepndence on trading partner
- Production capacity allocated to supply goods and services for export cannot be put to use meeting domestic needs and wants.
- Export-led growth might be unsustainable if it contributes extraction of natural resources beyond what is required for long-term balanced growth to be maintained.
What is the long run trend rate of growth
average sustainable rate of economic growth over a period of time. It is what tends to happen over a long period of time
What is an output gap
An output gap is the difference between the actual level of GDP and the estimated long-term value for GDP
What is a positive output gap
Actual GDP> long run trend rate
What is a negative output gap
Long run trend rate> Actual GDP
Why are output gaps difficult to measure
- Position of LRAS is unkown and intial estimates of GDP are often inaccurate
Portray +ve and -ve output gaps using a classical LRAS diagram
In the diagram, there is an equilibrium where AD=SRAS=LRAS. However, at AD1 , there is a negative output gap because the SRAS equilibrium is less than the LRAS equilibrium, so the full capacity of the economy is not being met. At AD2 , there is a positive output gap as SRAS is higher than LRAS.
How would a classical economist argue these output gaps would be fixed
Classical economists would argue that this positive output gap would be filled by long-run economic growth moving the LRAS curve, a recession which would decrease AD or a rise in the costs of production which would decrease SRAS. They would also argue that the negative output gap would be brought back to equilibrium by rising AD or a fall in SRAS due to lower costs of production.
What does this diagram show
The economy returns to Yf (full employment/equilibrium) following a period of deflation. There was no need to intervene justifying a laissez faire approach.
What is a paradox of thrift
Keynes argued in a recession, people responded to the threat of unemployment by increasing saving and reducing their spending. This was a rational choice, but it contributes to an even bigger decline in AD and GDP. This is why government intervention may be needed. (Defies Says Law)
What is an example of a paradox of thrift
High savings ratio in 2008 contributed to recession
What are some criticisms of the paradox of thrift
- Higher saving increases bank balances and can lead to an increase in bank lending - and hence investment. (Banks may be unwilling to lead)
- A fall in demand from higher saving, will cause lower prices, which encourage demand to increase. This is related to Say’s Law which states supply creates its own demand.
- Higher domestic savings can lead to lower domestic inflation and therefore increase exports. Higher exports can boost demand.
What is Says Law
the production of goods creates its own demand.
production creates wages for workers and income for the businessman. Therefore, the production has increased wealth and leads to demand for other goods.
What are the implications of Says Law
- The economy should always be close to full employment. There shouldn’t be demand deficient unemployment.
- Economic downturns are not due to a ‘glut of supply’
- According to classical economists, any unemployment must be due to **wages being artificially kept above the equilibrium level **or structural factors, such as lack of skills in specific industries.
- To increase output, we should concentrate on increasing production rather than demand.
What are the criticisms of Say’s Law
- 1930 mass ue shows there can be insufficient aggregate demand for goods produced.
- Wages are sticky downwards
- **Paradox of Thrift **: Say himself criticised Ricardo for neglecting the possibility of hoarding if there are insufficient investment opportunities. Lack of confidence
- Liquidity Trap. In a liquidity trap, the demand to hold cash is greater than the demand to spend. Banks increase their reserves and the saving rate increases, this leads to a fall in aggregate demand.
- It may be very rational to ‘hoard’ money – especially in a period of deflation or anxiety.
- The balance sheet recession of 2008-12, illustrated an example of where banks, consumers and firms were keen to pay off their debts and not spend all their income. This led to a prolonged recession
Draw and explain effects of a positive output gap
· R.GDP is now above trend and this can occur because with the rising demand firms will offer overtime/stay open longer etc.
· However this puts upward pressure on the price level (demand pull) and cost push. WHY?
· The SRAS curve now shifts in as COP rises. (please draw SRAS2)
· The economy returns to YFE but now at a higher price level (inflation)
There may be an increase in inflationary expectations also (why?)
What does this diagram show
Fiscal Policy + Multiplier can lead to demand push inflation
What is the trade cycle
periodic but irregular up and down movements in economic activity
boom –> downturn –> recession (slump) –> recovery
What are the two main types of a trade cycle
two main types of trade cycle: a mild trade cycle where GDP does not fall
during recessions but instead doesn’t grow by as much as the trend, and a more
extreme one
What is charcteristic of a boom
- High national income
- Economy working above PPF (Positive Output Gap)
- Increase imports to meet demad
- Inflationary pressure
What is charcteristic of a boom
- High national income
- Economy working above PPF (Positive Output Gap)
- Increase imports to meet demad
- Inflationary pressure
What is characteristic of a downturn
- Output and income fall –> fall in C and I and tax rev.
- Payments for benefits increase
- Accept lower wages due to high unemployment –> fall in inflation + imports
What is characteristic of a recession
- High unemployment
- Causes low C,I,M
- Inflationary pressure will be low, may be deflation
- GDP -ve for 2 quarters
What is characteristic of a recovery
- National income and output begin to increase with unemployment falling
- C,I,M increasing
- Inflationary pressure grows
What is hystersis
Economies do not bounce back to their previous level of growth
e.g. some may take retirement, some lose their skills or become discouraged causing a loss in physical and human capital discouraging investment
What is an example of Hystersis in the UK
In the period 8 to 13 February 2022, based on adults aged 50 to 70 years in Great Britain (GB) who have left or lost their job since the start of the coronavirus (COVID-19) pandemic and not returned to work:
The majority (77%) of adults aged 50 to 59 years said they left their previous job sooner than expected compared with 57% of adults aged 60 years and over
What are the benefits of economic growth for consumers
- There will be an increase in demand for housing as people have more money and so are able to afford to buy properties, which will increase house prices.
- Shares to increase in value and lead to positive wealth effect.
- Improved productive efficiency due to better technology could lead to **lower prices or higher quality goods. **
What are some costs of economic growth for consumers
- Growth in Inequality
- Growth in inflation
What are some benefits of economic growth on Firms
-
Investment will increase since businesses are more successful.
* Business confidence will improve so higher I - increased investment means technology will improve which is likely to increase productive efficiency and lead to lower costs.
- The combination of higher demand and lower costs is likely to lead to higher profits.
- Economic growth also provides the opportunity for new firms to establish themselves and allows existing ones to make more profit.
- Easier to access finance due to lower IR and higher confidence
What are some costs to economic growth on Firms
- Firms who sell inferior goods may lose out
- Changing technology may cause markets to disappear/greater automation
What are some benefits to economic growth for living standards
- Economic growth will result in lower poverty levels .
- Increase in supply –> increased jobs –> higher wages
- There will be more goods and services, lowering prices and improvin access
- Housing standards and the quality of food increases –> health increases
- Increased government spending will lead to improved living standards
- people with higher incomes are able to buy cleaner fuels and richer countries can devote resources for research and development of cleaner resources and ‘greener’, more efficient technology
What are some costs to living standards due to economic growth
- ** increased inequalities **between rich and poor; rich might even exploit poor for growth
- exploitation of the environment A rise in income means more people have access to electricity etc. and use it more freely. This causes depletion of non-renewable resources, concern about sustainability of growth for future generations and increased levels of pollution/waste/congestion.
What are Growth Pessemists
What is the tragedy of commons
individuals could limit their use so that they don’t deplete the common resource. However, there is a free-rider problem. Where people rely on others to cut back their production. If everyone free-rides and maximises their use, then we get a situation of over-consumption.
What are policies to overcome the tragedy of the commons
- Voluntary agreements need sense of civic responsibility
- Government regulation can limit fish catches or size of fishnets to allow young fish to escape.
- Clearly defined property rights the private owner has a stronger incentive to manage the resource for optimum outcome. However, the problem of property rights
What is an example of overcoming the tragedy of the commons in fishing stocks through gov. regulation
Officials determined that the population of midAtlantic bluefish was at an unhealthy level in the late 1990s. To recover this valuable fishery, federal managers implemented a nine-year rebuilding plan, which reached its goal a year
ahead of schedule, leading officials to declare bluefish fully rebuilt in 2009.
What are some benefits of economic growth on Firms
-
Investment will increase since businesses are more successful.
* Business confidence will improve so higher I - increased investment means technology will improve which is likely to increase productive efficiency and lead to lower costs.
- The combination of higher demand and lower costs is likely to lead to higher profits.
- Economic growth also provides the opportunity for new firms to establish themselves and allows existing ones to make more profit.
What is percentage growth
Potential growth is the change in productive potential of the economy over time, so the LRAS or PPF curve shifts.
