2.5 Economic growth

Question 1

What is potential economic growth?

Answer 1

• Expansion of the productive capacity or potential output of an economy
• Can be shown by an outwards shift in the PPF
• Can be shown by the shifts in thw LRAS supply curve

Question 2

LRAS Curve Diagram (Potential economic growth)

Answer 2

Question 3

How can we increase the productive potential?

Answer 3

• An increase in one of the factors of production
• The efficiency or productivity of the factors improved, for example by training or technology

Question 4

What is potential output?

Full employment GDP or GNI

Answer 4

• An estimate of the value of output that the economy would have produced if labour / capital had been employed at their maximum sustainable rates - that is rates that are consistent with steady growth and stable inflation
• Its hypothetical and is very difficult to accurately measure

Question 5

What is actual output?

GDP or GNI

Answer 5

• Is the total output of an economy over a period of time (usually a year)
• Can be estimated using the GDP or GNI (GNI takes into account of income flows between countries)

Question 6

What is the Output Gap?

Answer 6

• The difference between potential and actual outputs
• Keynsian economists believe that macroeconomic equlibrium (Y2, P2) can be reached at a level below full employmenr (Yf)
• The difference (Yf-Y2 is called the output gap)

Question 7

Limitations of GDP as an indicator of living standards (Evaluation points)

Answer 7

• Differences in the distribution of income and wealth - No difference in income distribution is taken into account in the GDP/capita figures
• The average income can be a misleading factor if unfair distribution
• Externalities - Negative externalities are 3rd party effects that cause a reduction in welfare and they are mostly missed out of GDP calculations
• For example, when someone burns coal to make and sell electricity, you might suffer from global warming even if you haven’t used the electricity
• The hidden economy / black markets - goes unrecorded, criminal in nature, up to 15% of GDP could be in the hidden economy
• Non-Market goods - Self-sufficient of substience as people grow food/crops for themselves

Question 8

Nominal vs Real GDP

Answer 8

• Nominal is measured at current prices whereas real is adjusted for inflation
• Real GDP is essentially a measure of the volume of output
• Real GDP = Nominal GDP X a ‘deflator’ (either constant prices or an inflation index eg CPI)

Question 9

Value vs Volume

Answer 9

• Volume x Price = Value
• Volume is estimated by using constant prices
• If the value of output at castant prices has risen then the volume of output must have gone up

Question 10

What is Purchasing Power Parity GDP?

Answer 10

• PPP compares GDP by using the cost of buying the same basket of goods in each country
• Then using this to convert the value into the same currency for comparison
• This is better than using market exchange rates because standards of living are eecognised through purchasing power
• However it is difficult to measure and sometimes lacks data, just an estimate, and you must have the same basket of goods

Question 11

What are the three ways GDP can be measured

Answer 11

• The expenditure approach
• Income approach
• Value added approach

Question 12

What are the benefits of economic growth for consumers?

Answer 12

• Higher standard of living and more utility
• In industrialised countries there is an expectation of long term increase in incomes and resources
• Also an increase in human capital such as health and education
• Easing of poverty in developing countries

Question 13

What are the benefits of economic growth for firms?

Answer 13

• Growth means more sales + revenue and therefore an increase in profit
• Profit allows more investment in new technology. Retained profit finances 70% of investment

Question 14

What are the benefits of economic growth for governments?

Answer 14

• Fiscal dividens -An increase in tax revenue as a result of inflation which may be used either to reduce tax rates or to increase public expenditure or some combination of the two - collects more tax
• Public spending reduces on welfare spending
• Reduces debt to GDP ratio and more able to provide public goods

Question 15

Costs of economic growth (Evaluation)

Answer 15

• Inequality and poverty - A ‘growth first’ approach can lead to inequality and extreme poverty in LDCs
• Inflation can erode the benefits of growth - Shifts in AD will lead to pressures on prices and may be inflation (Not a shift in AS)
• (shoe leather costs / costs to savers) and may even cause a reversal of growth (hyperinflation, breakdown of the price mechanism, reduction in investment, depreciation of currency and rising interest rates)
• Labour shortages - cage inflation
• If growth is related to new technology the possibiity of a skill gap and structural unemployment
• Pollution and degradation of the environment - China, growth since 80s pollution bad air and water quality, depletion of non renewable resources

Question 16

Long-run or potential economic growth

• Long-run economic growth is caused by any improvements to the quality or quantity of the factors of production
• These factors include all of the determinants of long-run aggregate supply

Answer 16

• A change to the quantity/quality of the factors of production has increased potential output of the economy from YFE→YFE1
• E.g. More rigorous competition policy creates a higher number of firms in each industry, leading to greater aggregate supply in the economy
• This shifts the long-run aggregate supply curve to the right LRAS1→LRAS2, resulting in economic growth
• The final impact on price levels depends on the shape of the long-run aggregate supply curve (Keynesian or Classical)

Question 17

What is actual economic growth?

Answer 17

• Actual economic growth occurs when there is an increase in the quantity of goods/services produced in an economy in a given period of time
• This is often measured by the percentage change in real gross domestic product (GDP)

Question 18

What is potential economic growth?

Answer 18

• Potential growth is the increase in the productive potential of an economy as demonstrated by a shift outward of the production possibilities frontier (PPF) or the long-run aggregate supply (LRAS) curve
• At any given point in time, the actual economic growth may be less than the potential growth available to the economy

Question 19

Define Export-led Economic Growth:

Answer 19

• Export-led economic growth refers to growth that occurs as a result of an increase in the sale of goods/services to foreign countries
• Net exports (X-M) is a component of aggregate demand (AD)
• For many developing countries, the exports represent a high percentage of the annual AD and gross domestic product (GDP)
• When the value of the exports rise, the real GDP rises significantly - and vice versa

Question 20

What is a trade business cycle?

Answer 20

• A trade (business) cycle refers to the changes in real GDP that occur in an economy over time
• This is the actual growth
• The real GDP will fluctuate above and below the long-term trend rate of growth
• There are four recognisable points in the cycle
• Peak/boom; slowdown/downturn; recession, recovery

• This flow of real GDP can be moderated by government intervention
• E.g. increasing taxes in a boom period or increasing spending in a recession

Question 21

A Table Explaining the Characteristics of a Boom and Recession:

Answer 21

Question 22

A Table Summarising the Benefits and Costs of Economic Growth:

Answer 22