2.5 - Economic growth

Question 1

What is economic growth?

Answer 1

A rise in the real value of goods and services being produced in a given period of time

Question 2

What causes short-run growth?

Answer 2

Changes to any of the components of aggregate demand (AD) will cause short-run economic growth to occur
- Can be illustrated on an AD/AS diagram by a rightward shift in AD
- It can also be illustrated by using the PPF model by moving from a point inside the curve to a point closer to the curve

Question 3

What causes long-run growth?

Answer 3

Long-run economic growth is caused by any improvements to the quality or quantity of the factors of production - includes all of the determinants of long-run aggregate supply
e.g. discovery of new resources (land) such as oil will increase long-run economic growth

Question 4

What is the difference between actual growth and potential growth?

Answer 4

Actual growth: occurs when there is an increase in the quantity of goods/services produced in an economy in a given period

Potential growth: a change in the productive potential of the economy over time, so the LRAS or PPF shifts

Question 5

What is a long-term growth trend?

Answer 5

• The underlying trend rate of economic growth over a longer period of time
• This is determined by the constant increases in the productive capacity of an economy (aggregate supply)
• The increase in productive capacity is illustrated by a rightward shift of LRAS
• Use of long-term growth trends can reduce the impact of outliers in the data

Question 6

What is an output gap?

Answer 6

The difference between the actual level of output (real GDP) and the maximum potential level of output

Question 7

What is the difference between a positive and negative output gap?

Answer 7

Positive output gap: when real GDP is greater than the potential real GDP
Negative output gap: when the real GDP is less than the potential real GDP - spare capacity in the economy to produce more G&S

Question 8

Why is it difficult to measure output gaps accurately?

Answer 8

• It’s hard to know exactly what the maximum productive potential of an economy is
• Rapidly rising prices can indicate a positive gap is developing
• Rising unemployment and slowdown in economic growth can indicate that a negative gap is increasing

Question 9

What is a recession?

Answer 9

Two or more consecutive quarters of negative real GDP growth

Question 10

What is the importance of international trade for export-led growth? (define export-led growth)

Answer 10

• Export-led growth: where the driver of growth is an increase in the export component of AD
• Balance of payments will improve as more goods and services are sold abroad
• Makes exporters vulnerable to changes in demand in other countries, or exchange rates, which are out of their control

Question 11

What constraints are there on growth?

Answer 11

• Absence of efficient capital markets -> asymmetric information in credit markets where the lender knows little about the borrower and charges high rates to cover high-risk
• Government instability: can’t attract investment and currency may be unstable
• Labour market problems: as countries get richer, birth rates tend to fall -> fall in labour supply in the long run
• External constraints: e.g. global recession

Question 12

What is a boom?

Answer 12

A period of rapid economic expansion resulting in higher GDP, lower unemployment, a higher inflation rate, and rising asset prices

Question 13

What are the benefits of economic growth?

Answer 13

• Consumers: incomes and wealth rises; increased job confidence; more employment opportunities & wage rises
• Firms: tend to make more profit -> firms can take on more workers + more likely to invest -> increases future growth prospects
• Governments: as income and assets rise, people pay more income tax + firms pay corporation tax; less benefits
• Current & future living standards: total incomes are rising so people feel better off; firms can afford cleaner technology; increased tax revenue = increased gov spending on improving infrastructure

Question 14

What are the costs of economic growth?

Answer 14

• Income inequality: unwaged and unskilled are less likely to benefit from increased incomes
• Environmental problems: depletion of natural resources, pollution, etc -> however govs can use their increased tax revenue to enforce carbon control measures and clean up the environment
• Balance of payments problems on the current account: higher incomes -> domestic consumers demand more imports and there is less incentive for firms to export