2.5 Economic Growth

Question 1

What is short run economic growth ?

Answer 1

• an increase in real GDP ie. an increase in actual output
• also known as actual growth (the % annual increase in a country’s real GDP over a period of time)
• caused by an increase in AD

Question 2

What are the causes of short run economic growth ?

Answer 2

• changes in interest rates
• fiscal policy (changes in govt spending and taxation)
• commodity princes eg. oil, gas and food
• currency changes (affect export and import demand)
• trading conditions in other countries eg. competitive exchange rates
• confidence of businesses and households

Question 3

What is long run economic growth ?

Answer 3

• also known as potential growth
• a sustained rise in a country’s productive potential
• the main drivers of this is higher productivity and gains from innovation and rising real incomes for households
• caused by an increase in AS
• potential output is that which could be produced if there was full employment of resources

Question 4

What are the causes of long run economic growth ?

Answer 4

• investment
• productivity
• labour supply
• research and development
• innovation
• enterprise

Question 5

What is export led growth ?

Answer 5

• where a significant part of the expansion of real GDP, jobs and per capita incomes flows from the successful exporting of goods and services from one country to another
  🔔 export led growth important for many countries but have to ensure they are exporting a sufficiently diverse range of products (eg. avoid risks from primary product dependancy) + the benefits from increased exports and growth are widely dispersed across the population

Question 6

What are the advantages of export led growth ?

Answer 6

1. exports are an injection into the circular flow leading to a rise in AD and an expansion of output, this helps to raise per capita incomes and reduce extreme poverty especially in developing countries
2. growing export sales provide revenues and profits for businesses which can then feed through to an increase in capital investment spending through the accelerator effect, higher investment ➡️ increased productive capacity ➡️ increases potential for exports
3. many industries help to facilitate trade such as trade insurance, logistics and port facilities, countries with fast-growing export sectors are likely to see increased investment and employment in these related industries

Question 7

Advantages of export led growth ?

Answer 7

• rise in AD and expansion of output
• growing export sales = more profits
• increased investment and employment

Question 8

What are the potential risks of export led growth ?

Answer 8

• over dependence on the economic cycles of trade partner countries ➡️ vulnerable to external economic and political shocks
• encourages/incites a protectionist response from other nations who feel that the benefits of trade have been unequally skewed in favour of exporting countries
• allocated goods and services for exports cannot be used to meet domestic needs and wants ➡️ cause dip in domestic living standards unless the country is also prepared to import goods and services using the revenue from exports
• rapid export led growth might lead to demand pull inflation + higher interest rates ➡️ export industries less competitive in overseas markets + domestic producers less price competitive against imports
• might be unsustainable if it contributes extraction of natural resources beyond what is required for long term balanced growth to be maintained eg. deforestation

Question 9

What is the output gap ?

Answer 9

• the difference between the actual level of GDP and its estimated potential level (usually expressed as a % of the level of potential output)

Question 10

What is a negative output gap ?

Answer 10

• occurs when the level of actual GDP is less than potential GDP, large margin of spare capacity
• some factor resources are under-utilised eg. demand deficient unemployment, suggests economy is under efficient
• main problem is likely to be higher unemployment + possible deflation risk
• policies used: lowering interest rates

Question 11

What is a positive output gap ?

Answer 11

• occurs when actual GDP is greater than the estimated potential GDP, possible excess AD
• some resources working beyond usual capacity (shift work & overtime), suggest economy is very efficient
• main problem is rising demand causing pull & cost push inflationary pressures
• policies used: raising interest rates

Question 12

Why is it difficult to asses the output gap ?

Answer 12

hard to measure/asses:
- productivity
- size of labour force
- business output and confidence
- underemployment

Question 13

Showing output gaps using AD/AS diagrams

Answer 13

• negative output gap: LRAS past equilibrium
• positive output gap: LRAS before equilibrium

Question 14

What is an economic boom ?

Answer 14

• a period when the rate of growth of real GDP is fast and higher than the long-term trend

Question 15

What is a slowdown ?

Answer 15

• a weakening of the rate of growth, real GDP is still rising but increasing at a slower rate

Question 16

What is a recession ?

Answer 16

• a period of at least six months when an economy suffers a fall in aggregate output, employment, investment, real incomes and confidence ie. fall in GDP

Question 17

What is economic recovery ?

Answer 17

• a phase after a recession, during which real GDP starts to increase and unemployment begins to fall

Question 18

What is a depression ?

Answer 18

• a prolonged downturn in the economy and where a nation’s GDP falls by at least 10%

Question 19

Characteristics of a boom ?

Answer 19

• rising incomes
• rising confidence
• rising employment
• rising wages
• rising inflationary pressure
• rising business profits (unless the business sells inferior goods)
• rising trade deficit
• increasing use of scarce resources
• rising investment, the ‘accelerator effect’ will cause investment to rise more quickly than GDP
• rise in construction
• falling budget deficit ie. falling govt borrowing

Question 20

Characteristics of a recession ?

Answer 20

• falling incomes
• falling confidence
• rising unemployment
• stagnant wages
• falling inflationary pressure (if caused by lack of demand)
• falling business profits (unless the business sells inferior goods)
• falling trade deficit
• possible less use of scarce resources + reduced environmental damage
• falling investment, the ‘accelerator effect’ will cause investment to fall more sharply than GDP
• fall in construction
• rising budget deficit ie. rising govt borrowing

Question 21

What are the possible causes of a recession ?

Answer 21

• external events: a recession in a trading partner eg. EU or a sharp rise in global commodity prices eg. rising oil prices
• tightening of macro policy: higher interest rates leading to more expensive loans or a rise in taxation or a cut in govt spending
• fall in asset prices or supply of credit: steep decline in the level of share or house prices or a collapse in the supply of credit eg. global financial crisis
• drop in business and consumer confidence: businesses cut investment ➡️ job losses OR less spending and more saving

Question 22

Recession caused by an inward shift of AD ?

Answer 22

• AD decreases, leading to an increase in spare capacity i.e. a rising negative output gap, and a fall in real GDP from Y to Y1.

Question 23

Recession caused by an inward shift of AS ?

Answer 23

• can also be caused by a supply shock, leading to an inward shift of short run AS
  eg. higher import prices ➡️ rise in general price level ➡️ lower real incomes for consumers and falling profits for business
• a supply shock may lead to a period of stagflation (slower economic growth and higher inflation)

Question 24

What are the short term effects of a recession ?

Answer 24

❗️impact depends in part on causes and how long it lasts
- fall in business profits and capital investment: due to falling demand as well as planned investment declining
- unemployment: steep decline in AD ➡️ fall in demand for labour ➡️ rise in cyclical unemployment
- growing fiscal deficit: decline in tax revenues and more welfare spending ➡️ increased budget deficit + rising national debt
- lower rate of inflation: businesses offer price discounts to off load excess unsold stocks, deep recession risks causing a period of sustained deflation

Question 25

What are the long term economic effects of a recession ?

Answer 25

• rising structural long-term unemployment and regional decline
• low rates of investment can reduce the size of the capital stock
• persistent budget (fiscal) deficits and a rising national debt leads to austerity (cut in public services)

Question 26

What are the long term social effects of a recession ?

Answer 26

• falling real wages hits average living standards and reduces demand
• widening inequality of income and wealth leading to rising poverty
• social costs such as loss of social cohesion and threats to democracy

Question 27

What are the benefits of economic growth ?

Answer 27

• higher living standards: real GNI per capita, helps to lift people out of extreme poverty + improves development outcomes
• employment: sustained growth creates jobs + contributes to lower unemployment ➡️ reduces inequality, poverty and social problems
• fiscal dividend: raise in tax revenues, allowing govt to spend more on public and merit goods or help cut a fiscal deficit
• accelerator effect: rising growth stimulates new investment eg. in low-carbon technologies and it provides profits that fund research and innovation
• greater business profits: stimulates further investment, R&D, innovation
• additional income can be used for savings: this provides protection against future loss of income due to sickness / lack of demand, can support retirement, deposits for houses etc or can be used to pay for more
  leisure time

Question 28

What are the costs of economic growth ?

Answer 28

• risks of higher inflation & interest rates: can lead to demand pull and cost push inflation, central banks may decide to raise interest rates to control inflation, rising consumer spending ➡️ increasing trade deficit
• environmental effects: negative externalities eg. pollution and waste + risk of unsustainable extraction of finite resources, causing a long run depletion of natural resources
• inequalities of income & wealth: rapid growth can lead to a higher level of inequality and social divisions, the distribution of gains from growth are often unequal (may only go to a few people but the growth may be at the expense of hours worked and increased stress)

Question 29

What does the impact of economic growth depend on ?

Answer 29

🔔
- the cause of the growth
- actions taken by the government / central bank to prevent excessive growth
- consumer and business attitudes
- the rate of growth
- legislation in place to protect the non-working, the environment etc